hi everyone welcome back to sahab academy now in this video we're going to see this another technique of capital budgeting which is called discounted payback period and this discounted payback it is just an extension of that simple payback which we have seen in the second video of this chapter yeah so that simple payback you have to understand properly so that's why what we're going to do first is we are going to revise what that simple payback was okay and then we'll come back to this discounted payback is that okay right so let's do that see here in simple payback what we used to do was we used to calculate how much time will the project take to recover its initial investment yeah for example if a project has initial investment of 100 and the future cash inflows are rupees 20 at the end of each year they are constant same then what you could do was you could use this formula initial investment divided by annual cash inflow and you could easily get the simple payback period see here initial investment is 100 divided by the annual cash inflow rupees 20 divided by 20 that is equal to five years so the project is taking five years to recover its initial investment yeah so this is how you have to calculate the simple payback simple right yes but you can use this formula only when the cash flows are constant when they are same okay but what is the decision criteria in simple payback see the general rule is what we do is we select the project which has the shortest payback period yeah the sooner we get our money back the better yes so that's what sometime what can happen is sometimes the management will tell you that maximum you have to select the project which has maximum three years payback four years payback period yeah if the management gives you that guideline then you have to compare your payback period yeah the payback period of the project with the management cut off rate if the management is saying you know three years and you have four years in your question then what you have to do you have to reject that project yeah you understand that so that's what we used to do in simple payback and if the cash flows are not constant if they are not same then what we used to do we used to make use of this calculation yeah cumulative calculation isn't it we used to take the negative figure go on adding it up yeah and then whenever we used to get the positive figure it means in that year you have recovered the initial investment i mean the project has recovered its initial investment and then to know it exactly in terms of years and months to be exact precise what we used to do we know that it has happened after year three here in year four yeah after year three so three year plus something some decimal is there some months it is taking so to know that exact months and everything what we used to do see here it is happening here in the fourth year 40 000 positive figure we are getting so what we used to do was we used to take the previous figure yeah minus 160 divided by this side figure 2 lakh yeah we used to do this calculation 160 divided by 2 lakh that is equal to 0.8 now this is just decimal this is not months okay don't confuse that this is not months this is just a decimal 0.8 so the payback period simple payback period is 3.8 years it is 3.8 years but if you want to know in exact months then what you have to do you have to take the 0.8 and you have to multiply that by 12 into 12 so it is 9.6 months okay so this way you have to do it so how much time it is taking it is taking three and nine point six months is that okay yeah so this was the simple payback now let's get back to the discounted payback now let's understand the discounted payback see the meaning over here it is similar to the payback method but uses discounted cash flows to measure the payback period yes that's the core of this technique isn't it what we have to do here we have to discount the cash flows first to the present value and then we have to apply the payback technique okay so it is also known as adjusted payback why because we take the future cash flows and we adjust them isn't it we discount them to the present values that is why it is also known as adjusted payback technique okay so see here what you're going to be doing over here is you'll be taking the future cash flows from the question and multiply that with the discount factors you will get the present value on these figures on the present value you will apply the payback technique now what is payback technique the same thing which you have seen in the second video yeah this cumulative technique what you have to do take the initial investment as it is and then go on adding to that the inflows of cash which will be having but in the second video in simple payback we had only future cash flows here you are having present values yeah so that's why you will not call it as cumulative cash flow no you will call it as cumulative present value or cumulative net present value okay so the wording is different fine and then rest all the calculation and everything will be same you will go on adding it up yeah and then when you will get the positive figure that means in that year you have recovered the initial investment the project has recovered the initial investment and to know it exactly you have to make use of this calculation okay so that's what you have to do the calculation everything is same the only thing that is different between simple payback and discounted payback is you will be discounting the cash flows that's all it is rest all 95 percent of the calculation everything is same only okay and then the decision criteria is also same yeah and this also you have to know see here dpp technique takes time value of money into consideration isn't it because we have discounted the cash flows to present values so time value of money is taken into consideration yeah that was the limitation of simple payback in simple payback we didn't consider the time value of money we used to take directly the future cash flows yeah that's the drawback of simple payback the time value of money is not considered that drawback is overcome in the discounted payback because here you discount the cash flows to present values is that okay right and then the decision rule is you all know if we have many projects and what we do is we select the project which has the shortest payback period yeah the sooner we get our money back the better fine yeah and i've already told you that see here sometime what will happen sometime the management will give you a target period yeah see here a company can set a target dpp discounted payback period and choose not to undertake any project with a dpp discounted payback period in excess of a certain number of years for example say four years now here what are they saying is see the company will tell you maximum four years you don't need to select any project which is above four years yeah you have to be below four years or exactly par with four years yeah that's what the decision criteria is yeah simple as that is that okay yeah so you don't have to go in excess if any project goes in excess you have to reject that project is that clear right so that's all discounted payback is now let's just see one problem and you'll be practically clear with this now here we have the problem see the question over here calculate dpp discounted payback period of the following project and give recommendation so first we have to calculate the dpp and then we have to give the recommendation to the company whether the company needs to accept the project or reject the project is that okay yes and then in the bracket here they have given as maximum dpp maximum discounted payback period can be three years so if the project is above three years if the dpp of the project is above three years we have to reject the project if it is below or equal to three years we have to accept the project yeah that's what i have said while explaining the dbp concept yes so see here we have the cash flows over here first we have the initial investment minus one lakh that's the cost of the project and then we have the cash inflows that we're gonna have at the end of the first year at the end of the second year and so on thirty thousand fifty thousand forty thousand thirty thousand two thousand right then they are saying here use ten percent for discounting of course we have to discount the cash flows so what is the rate we are going to use it is given in the question 10 percent is that okay fine you see it's very simple let's start first what you're going to do you're going to have these columns yeah yeah cash flows yeah the same thing you are going to copy here and then discounting factors at 10 percent they have said 10 so you have to take out your calculator 1 divided by 1.10 is equal to at the end of the first year 0.909 yeah and just go on pressing equal to you will get the discounting factors equal to 0.826 equal to 0.751 and so on is that okay now if you have a scientific calculator then how you're going to do this see here it's very simple 1 divided by can you see this yeah 1 divided by 1.10 yeah is equal to that is equal to 0.909 this is the discounting factor after one year but then what you have to do you have to take powers so see here what you have to do put the brackets yeah put the brackets and take power so 2 power 2 that's equal to 0.826 and then just you know change the powers that's all you have to do yeah delete 3 that's equal to 0.751 delete sorry what is happening here delay 4 0.683 like that you have to go on calculating the discounting factors is that okay fine so you have got the discounting factors all the discounting factors then what you have to do multiply the cash flows these are the future values you have to multiply them with the discounting factors you will get the present values yeah let me just show you one wait wait wait here i have not completed this yeah you see here now this investment happened on the first day itself so here there will not be any discounting factor it will be one only because it's on the first day itself yeah it's not future value it's present value only one lakh into one one lakh okay so that's what and then here let me just show you one thirty thousand into zero point nine zero nine that's equal to twenty seven thousand two seventy yeah just multiply these two you will get the present values yeah all the present values and then if you add up all the present values what do you get you get the net present value you know that right so if you add up all of this you get net present value isn't it yes so net present value we don't need that i have just shown you if we add that we get net present value okay so what we need actually we need discounted payback period so to calculate that what we have to do we have to now apply the payback technique and what is that see here cumulative npv that's what we do right first we take the negative figure as it is the initial investment and this is what we have to recover so take that into the calculator minus one lakh yeah minus one like this is minus okay right now then you go on adding it up see here let me just put this to site can you see it yeah so one lakh plus 27270 yeah go on adding all the cash inflows in the present value term yep then that's equal to seventy two thousand seven thirty yeah minus it's still in minus you have to recover seventy two thousand seven thirty more to recover that entire one lakh okay so go on go on adding it up plus 41 300 that's equal to 31 430 still it's in minus so you need additionally 31 430 to recover that one lakh so go on plus 3040 3040 that's equal to minus 1 3 9 0 still negative yeah you need 1390 more to recover the initial investment plus 20 490 that's equal to 19 100. so now the figure has turned to positive so if it has turned to positive that means we have recovered our initial investment after year three in the year four we have recovered after year three so immediately you can come to know that we have to reject this project because the recovery is happening in the fourth year somewhere in fourth year yeah somewhere in fourth year and you know our target dpp is maximum three years so we have to be below three years or at par with three years but the dpp of this project is going above three years in the year four so we have to reject the project but we have to complete the whole solution and you know present it properly the solution the reason and everything so 19100 we got that then what you have to do go on continue plus 12 420 yeah complete the solution that's equal to 31 000 520 yeah 315 is that okay yeah then what you have to do you have to show them exactly the dpp you have to calculate and show presented properly yeah so see here what you have to do dpp is equal to the same way in symbol payback how we used to do the same way you have to do yeah it has happened after year three it has happened after year three so of course three years has been passed three years has been passed so directly you can take three years plus some decimals is there isn't it because it has happened in the year four somewhere in year 4 so that's why some decimal is there and that decimal you have to calculate that accurately so how you're going to do that i've already told you this is the positive figure you have you have to take a fraction of the previous figure and the side figure the previous figure and the side figure previous by side previous by side that's what you have to do okay so 1390 divided by 2490 yeah 20 000 490. so 1390 divided by twenty thousand four ninety that's equal to zero point zero six seven eight yeah now this is not months okay this is not months don't confuse no it's in the year form only three plus zero point zero six seven so that's equal to 3.067 years if you do till here also you will get the marks if you want to present it more you know accurately what you can do is see you can take the 0.067 and convert it into months zero point how much was that let's do that one three nine zero divided by twenty four nine zero i need the whole decimal that's what so that's equal to zero point zero six seven at something yeah so this decimal you have right just multiply this by twelve to convert it in the months yeah right now it is in the year it is in the year format to convert it into months you have to multiply by 12 you will get what zero point eight one four zero so still it is what it's not even one month also it's below one month zero point eight months yeah you have got this in months now zero point eight months so see here i have shown you both the ways three plus zero point zero six seven into twelve so three years and zero point eight month you can also say you know three years and one month so it is exceeding our target dbp our target dpv was three years only maximum maximum the management told us if this project goes above three years you have to reject the project yeah that's the guideline we have from the management so what we have to do the dpp of this project is three years and 0.8 months you can say one month yeah three years and one month so we have to give the recommendation to the management that this project should be rejected because we have calculated and through our calculation we come to know that the dpp the dpp of this project exceeds target dpp which you have provided us is that okay so that's what you have to do and this is it this is the discounted payback period technique of capital budgeting yeah what did i do over here first i converted the future values into present values and you don't need to multiply or discount the what the initial investment because it's happening on the day one yeah so it's into one only and then how did i do this cumulative npv first i took the minus figure as it is the initial investment and then i went on adding up the present value present value of the inflow see here what did i do minus 1 lakh first i took minus 1 lakh plus 27 2 7 0 that's equal to minus 72 730 then plus 41 300 that's equal to 31 430 in negatives it was coming in negative negative then positive so when it comes in positive you need to know you have recovered the project has recovered the initial investment yeah in that year so of course three years has been passed so directly you can take three plus something something is there write some fraction some decimal because it is the recovery is happening in the year four so that's why you have to calculate that exactly and to calculate that exactly what you have to do this is the positive figure you have to take the previous figure divided by side figure previous figure divided by side figure previous by side okay previous by side you will get the decimal and this will be in the year format you can also convert that into months by multiplying it with 12. is that okay so this is it fine i hope you have understood each and everything yeah i have been in very much detail over here okay then see in the next video yeah that's it for today bye