Payback Method Research Articles

Economic Evaluation of Photovoltaic Plants in Greece under the Recently Introduced De-Escalating Feed-in-Tariff Policy

The present paper investigates the economic viability of an investment in photovoltaics, or solar panels, in Greece. The point in time of our research is critical, as the recently introduced de-escalating Feed-In-Tariff policy signals important changes in the options of a potential investor and the Greek electricity market on the whole. The structure of the paper as financial report analysis gives intuition over the several choices available to a potential investor. The presented current market and legal background frames the potential of the investment. The analytical part in implemented under the capital budgeting methodology, including Cash Flows Analysis, NPV Analysis, IRR and robustness check with Ratio Analysis and the Simple Payback Method. Implementing the methodology mentioned and with the help of sensitivity and scenario analysis, the results illustrate the choices that a potential investor has in short-term horizon and how these choices can affect the project’s efficiency.

Capital Budgeting and Political Risk: Empirical Evidence

AbstractThis paper surveys and investigates Swedish firms' use of capital budgeting techniques for foreign direct investments. We document that the use of the theoretically correct net present value method decreases with the political risk in the host country, and that the use of the Payback method increases with the political risk. We conclude that in the presence of capital market imperfections, unsystematic and country‐specific political risks are important. Because these risks are difficult to estimate (rendering high deliberation costs) managers are inclined to use simple rules of thumb for their capital budgeting decisions. Our results can partly explain why surveys find that alternative methods such as the Payback method are frequently used despite their theoretical drawbacks.

A Rational for the Payback Criterion: An Application of Almost Stochastic Dominance to Capital Budgeting

Textbooks on financial management have emphasized the shortcomings of the payback criterion for decades. However, empirical evidence suggests that in actual capital budgeting procedures the payback method is used quite regularly. Mostly, it is implemented supplementary to net present value or internal rate of return, but small companies tend to rely on payback times as single criterion. A convincing theoretical foundation for the observed use of the payback criterion is lacking. Consequently, our goal is to provide such an explanation for the payback criterion’s popularity. We demonstrate from a decision theoretical perspective how relying on payback times simplifies investment decisions in modern organizations. Gathering information from different management levels and ensuring the utilization of individual skills requires a multi-stage capital budgeting process. Accordingly, we consider fundamental organizational features of this process with respect to their impact on the payback method’s use. For this purpose, we built upon almost stochastic dominance (ASD) as modeling device. Firstly, we show that applying his concept allows to include the risk preferences of all relevant decision makers into the analysis. Secondly, we illustrate that the criteria derived from this model help conveying these preferences to those who do the preparatory work preceding the final decision. To some extent, these new criteria are generalizations of payback times. This finding provides a potential explanation for the payback’s persisting prominence.

Benchmarking Hotel Capital Budgeting Practices To Practices Applied in Non-Hotel Companies

A survey was conducted to compare hotel capital budgeting practices employed within and outside the hotel sector. It was found that the propensity to inflate investment cash inflow projections outweighs the propensity to deflate cash inflow estimates, and the tendency to inflate projected cash inflows is less in the hotel industry. Hotels exhibit a lower level of development with respect to reviewing required rates of return and also applying postcompletion audits. Also, net present value and internal rate of return, which are based on discounting approaches, are used to a relatively low degree in the hotel industry, and more than half the hotels surveyed either exclusively use the payback method (36%) or use no financial investment appraisal method at all (17%). Consistent with prior findings in other industrial sectors, there appears to be a positive relationship between organizational size and use of financial investment appraisal techniques.

Energy Savings Resulting from Building Envelope Upgrades in Mid-Rise Construction—A Case Study

Abstract The Bice House Dormitory on the campus “Grounds” of the University of Virginia was constructed in the mid-1970s as a dormitory for the nursing school. The building was an eight-story, concrete framed, residential facility with brick veneer cladding over steel stud framing systems. After more than 25 years of service, deficiencies in the brick façade, coupled with inadequate exterior wall framing, required removal and replacement of the entire exterior wall system from the interior drywall, up to and including the brick veneer. As part of the exterior wall replacement, window systems and insulation materials were upgraded. The building was also refitted with an air barrier system over the new exterior gypsum sheathing. Because existing individual packaged terminal air conditioning units were temporarily removed and reinstalled after renovation, the heating and cooling systems for the building remained unchanged, providing a unique opportunity to measure the true energy savings realized in a building strictly as a result of upgrading the building envelope. When the total heating and cooling costs after the first two full years of service were compared to the costs from years prior to the renovation (normalized for the temperature variations), a distinct reduction in energy costs were recognized from the improvements made during the renovation. The yearly energy consumption for the building was reduced by roughly 14 %, yielding a savings of roughly $12,800 per year based on current energy costs. Based on a payback period method of analysis, the improvements will have paid for themselves in roughly 14 years.

Capital Budgeting and Political Risk: Empirical Evidence

This paper surveys and investigates Swedish firms' use of capital budgeting techniques for Foreign Direct Investments. We document that the use of the theoretically correct net present value (NPV) method decreases with the political risk in the host country, and that the use of the Payback method increases with the political risk. We conclude that in the presence of capital market imperfections, unsystematic and country-specific political risks may be important and as they are difficult to estimate (rendering high deliberation costs), managers may be inclined to use simple rules of thumb. This type of behavior might partly explain why surveys find that alternative methods such as the Payback method are frequently used despite their theoretical drawbacks.

Evaluation of retrofitting a conventional natural gas fired boiler into a condensing boiler

The exit flue gas temperature of a conventional gas fired boiler is usually high and a great amount of heat energy is lost to the environment. If both sensible heat and latent heat can be recovered by adding a condensing heat exchanger, the efficiency of the boiler can be increased by as much as 10%. In this paper, based on combustion and heat transfer calculations, the recoverable heat and the efficiency improvement potential of different heat recovery schemes at various exit flue gas temperatures are presented by performing design calculations. The payback period method has been used to analyze the feasibility of retrofitting a conventional gas fired boiler into a condensing boiler in a heating system in detail. The results show that the most economical exit flue gas temperature is 40–55 °C when a conventional natural gas fired boiler is retrofitted into a condensing boiler simply by adding a condensing heat exchanger. It is feasible to use the return water of a heating system as the cooling medium of the condensing heat exchanger because the return temperature varies with the ambient temperature and is lower than the dew point of the water vapor in the flue gas in most periods of a heating season in some regions, which has been verified by retrofitted case.

Setting priorities for research

Setting priorities for research should be conducted in order to make the most efficient use of scarce resources. Yet the uptake in practice of such methods by researchers and commissioners of research alike has been slow, in part because the methodologies available to do so have not been widely disseminated. This paper argues that an appropriate priority-setting methodology should meet the objectives of the health system, that is to provide the most health benefits to the population that it serves within the budget constraint and while respecting equity considerations. A condition for these criteria to be met is to construct and operationalise an appropriate definition of the value of research. Five different ways that have been used in practice to value research and set priorities were reviewed. Shortcomings in the ways research is valued make it unlikely that the application of subjective methods, burden of disease methods, and clinical variations and payback methods meet the objectives of the health system. Using the fifth method, value of information, priority-setting can meet the objectives of the health system because it expresses the value of research using the same overall cost-effectiveness framework that is employed for decisions on service provision. However, this method still requires further work to evaluate how research outcomes can then be communicated to clinical practitioners and how practitioners can be encouraged to implement them.

Capital Budgeting and Entrepreneurial Organizations: A Survey of Hospital Practices

Efficiency and effectiveness for all entrepreneurial firms requires that limited resources be put to their best use. Thus the acquisition of long-term assets is an important decision for any entrepreneurial firm. For hospitals, which have become entrepreneurial to survive in today’s health care environment, long-term asset investment decisions have become critical to their survival. The objective of this study is to increase health care organizations’ awareness of the important considerations in selecting and monitoring long-term investments. Our findings from a small sample of American hospitals indicate that payback method is the primary criterion for evaluating hospital’s long-term investment projects. Also of note is the high proportion of hospitals whose approaches seem to incorrectly deal with the effects of inflation. On the other hand, the sample hospitals seem to be aware of the need to consider both tangible and intangible costs and benefits. They also exhibit awareness of the importance of follow up in the form of post audits.

Capital budgeting methods among Sweden's largest groups of companies. The state of the art and a comparison with earlier studies

This study presents a general description of the state of the art of capital budgeting methods used by Swedish corporations. It is based on a questionnaire sent to 528 companies selected from 500 of the largest Swedish corporations and some from the O-list of companies. The response rate is 24.4%. The study shows that the public sector companies are most frequent users of discounted cash flow (DCF) methods. The payback method is the most used in all industries; also matters size of company. The use of the net present value method has increased over the years, although the use of DCF methods is generally unchanged. Value-based management models have been introduced in the listed companies. Another conclusion is that tradition is an important factor explaining the choice of capital budgeting method. Large companies within the manufacturing industry use DCF methods more often than other companies. In general, the companies seem unconcerned with the tax consequences of capital budgeting decisions. It would appear as if the public companies have not adopted capital budgeting practices supporting shareholder value increases.

Managerial Advantages of using Payback as a Surrogate for NPV

ABSTRACT Existing literature identifies specific situations in which payback methods (PB) can provide precise surrogates for NPV analyses of accept/reject decisions. This paper extends that literature to take explicit account of taxation and of ranking decisions using profitability indices. Nevertheless, NPV can be considered preferable to PB as a basis for maximising stockholder wealth (MSW), because it requires fewer assumptions and provides more information. Yet simple PB continues to be used extensively, which suggests that it has advantages for decision-makers. Some authors suggest that its use reflects managerial short-termism and is inconsistent with MSW. In contrast, this paper proves that (with standard patterns of cash flows, defined risk classes and asymmetrical information) the use of PB instead of NPV should motivate risk-averse subordinate managers to adopt more positive NPV projects. Consequently, the appropriate use of PB can result in more wealth for stockholders than would occur using NPV directly. Furthermore, the use of PB avoids a number of costs and in the appropriate circumstances may therefore be the most cost-effective basis for evaluating investment decisions.

Development of aquaculture financial planning system

The Aquaculture Financial Planning System (AFPS) is a software that can be used as a tool to evaluate aquaculture investment. It is designed for general use, and is capable to deal with multiple culture species, crops, and catches. The software consists of three modules. An 18‐month statement of cash flow module can identify the periods when the business may be short on cash. The economic feasibility assessment module includes methods such as payback period method, rate of profitability, net present value, internal rate of return, cost‐benefit ratio, and break‐even analysis to evaluate the financial feasibility of aquaculture venture. The training on aquaculture planning module provides productivity analysis on capital, land, and aquaculture skill. Since the design of AFPS is based on the financial aspects, some degree of fish farming knowledge is required for users. AFPS is available from the authors for free.

HOW DO CFOs MAKE CAPITAL BUDGETING AND CAPITAL STRUCTURE DECISIONS?

This paper summarizes the findings of the authors' recent survey of 392 CFOs about the current practice of corporate finance, with main focus on the areas of capital budgeting and capital structure. The findings of the survey are predictable in some respects but surprising in others. For example, although the discounted cash flow method taught in our business schools is much more widely used as a project evaluation method than it was ten or 20 years ago, the popularity of the payback method continues despite shortcomings that have been pointed out for years. In setting capital structure policy, CFOs appear to place less emphasis on formal leverage targets that reflect the trade‐off between the costs and benefits of debt than on “informal” criteria such as credit ratings and financial flexibility. And despite the efforts of academics to demonstrate that EPS dilution per se should be irrelevant to stock valuation, avoiding dilution of EPS was the most cited reason for companies reluctance to issue equity.But despite such apparent contradictions between theory and practice, finance theory does seem to be gaining ground. For example, large companies were much more likely than their smaller counterparts to use DCF and NPV techniques, while small firms still tended to rely heavily on the payback criterion. And a majority of the CFOs of the large companies said they had “strict” or “somewhat strict” target debt ratios, whereas only a third of small firms claimed to have such targets.What does the future hold? On the one hand, the authors suggest that we are likely to see greater corporate acceptance of certain aspects of financial theory, including the use of real options techniques for evaluating corporate investments. But we are also likely to see further modifications and refinements of the theory, particularly with respect to smaller companies that have limited access to capital markets.

A Survey of Capital Budgeting Techniques in the Public and Private Sectors of a Less Developed Country (LDC)

ABSTRACT This study surveys the capital budgeting practice in private and commercially-oriented public sector enterprises in the Sudan, an African Less Developed Country (LDC). The study attempts to fill a gap in the existing literature by documenting the capital budgeting practice in an LDC where the economic environment is different than the developed and developing counterparts and where public sector still plays a major role in the economy. The study found a sizable number of commercially-oriented public corporations that do not use capital budgeting techniques in their capital investment decisions while the majority of private sector companies use these methods. Among the corporations that use capital budgeting methods, both in the public and private sector, the payback method (PB) is the most widely used method, followed by the Internal Rate of Return (IRR) and Net Present Value (NPV) in the private sector and the public sector respectively. The study also revealed additional factors such as cost, size, quality, experience and hard currency requirements that affect the capital budgeting process in both sectors. However, there are differences in the level of importance of these factors between the two sectors.

A Survey of Capital Budgeting Methods Used by the Restaurant Industry

ABSTRACT The purpose of this study was to determine what capital budgeting and cost of capital procedures are being used in the food service segment of the hospitality industry and to compare the responses, where possible, with those reported in the previous studies of capital budgeting techniques in the hospitality industry. The most popular primary capital budgeting techniques selected were the sophisticated or discounted cash flow methods, such as net present value and internal rate of return. The payback method was selected as a secondary technique.

Developments of the payback method

In spite of its theoretical deficiencies, the payback (PB) method is commonly used for appraisals of capital investments in companies. Sometimes the method is used when aspects such as liquidity and project time risk are focused, but it is also commonly used in pure profit evaluations as a single criterion. The two main deficiencies of the PB method are that it does not measure the time value of money in a correct manner and that it ignores cash flows after the payback period (PP). These deficiencies can be reduced if the maximum acceptable PP is chosen in a somewhat more sophisticated way. In practice the maximum acceptable PP is often chosen as a fixed value, e.g., three years. In some cases the limit value of the PP has been related to the economic life of the investment, e.g., a PP shorter than half the economic life. If these two rules of thumb are combined, a more theoretically correct evaluation of investments can be achieved. Such a combined PB method is based on the assumption of constant yearly cash flows. However, the method can be developed to handle cases with varying cash flows, but then some of its simplicity is lost. Due to the fact that the decision situations in the evaluation of capital investments typically are uncertain concerning the time pattern and the duration of the cash flows, this can justify the use of a simple but more robust PB method even if there would be time for more advanced analyses.

A comparison of capital budgeting models: local versus global viewpoints

This research studies the financial aspects of capital budgeting models in both the local and global perspectives. Since the development of the simple payback method, capital budgeting models have been employed as relative local measures of project evaluation. Because these tools analyze at a static local level, they are limited. By adopting simulation, the effects of capital expenditures and crucial interaction of resources in a dynamic global environment can be studied. Simulation software has improved greatly over the past few years and is becoming more and more common in the manufacturing and consulting environments. Hardware and software technology can provide a real opportunity for those making decisions regarding capital expenditures and can provide opportunity in the decision‐making process of the “what‐if?” scenario. Even though the traditional local optimization measures of performance may show a major advantage in making a purchase, the results of the global measures of performance may show it would bring about a significant financial misfortune to do so. One proven way to determine if the capital expenditure will improve the global measures of performance of net profit, return on investment and cash flow is to model the scenario through the use of computer simulation.

MEASURES OF LIQUIDITY RISK SUPPLEMENTING FUZZY DISCOUNTED CASH FLOW ANALYSIS

ABSTRACT Fuzzy discounted cash flow (DCF) techniques have been used to cope with the problems encountered by the deterministic or probabilistic evaluation of the investment alternatives. However, especially when a superior alternative cannot be spotted as a result of the DCF analysis, these techniques require a supplement such as the payback method or the duration analysis to assess liquidity risk. In this paper, 1 present fuzzy analogues of the payback method (conventional and discounted), which is a frequently used measure of liquidity risk in capital budgeting. Next, for investment projects, 1 propose a fuzzy economic evaluation criterion based on (he duration measure, which incorporates liquidity risk in capital investment while overcoming the obvious shortcomings of the payback method. Then, via a numerical example, I illustrate how to use the fuzzy payback method and fuzzy duration analysis as secondary decision criteria to rank investment alternatives, for which preference cannot be expressed in terms of fuzzy present worths.

CAPITAL BUDGETING TECHNIQUES USED BY SMALL BUSINESS FIRMS IN THE 1990S

ABSTRACT In recent times, small business firms have created 80 percent of the new jobs in the United States. Thus, their methodology for capital investment decisions is very important, though it continues to be somewhat different from that used by larger business firms. A questionnaire survey with 232 small business respondents indicates that the payback method is still the preferred approach by 42.7 percent of the firms. Unlike many larger firms, their time horizon is often the period over which a financial institution will extend them funding. In any event, the “average” minimal payback period in the survey averaged 2.81 years, a time period far shorter than the useful life of the asset and one that would indicate a required return far higher than most firms anticipate. Somewhat encouraging was the increased use of discounted cash flow methods (27.6 percent), which is a higher rate of utilization than that indicated in other surveys of smaller firms over the last few decades.

The payback method of investment appraisal: A review and synthesis

The payback (PB) method of investment appraisal has been the subject of considerable comment and criticism in the literature. This paper draws together some of those important literature contributions and the results from published UK and USA ‘survey’ reports over the past twenty-five years. While many of the surveys have reported an increasing use of the discounted cash flow financial appraisal methods, this has not totally been at the expense of the PB which continues to be a popular method used in industry. PB has been shown to be a traditional, popular, primary, and important method in both the UK and USA. The use of PB has been shown to be positively related to capital budget size. However, the importance of PB was seen to be inversely related to capital budget size. The use of PB has been shown by some researchers to be positively related to firm size, while other researchers have reported that its use is inversely related to firm size. However, it has also been concluded that the use of PB was not significantly influenced by firm size. PB has been shown to be less used for strategically important projects than routine replacement projects in moderately sized USA firms, while on the other hand it has been shown to be an important method used in the appraisal of advanced manufacturing technology (AMT) projects in both the UK and USA. This paper reviews the PB method of investment appraisal as used in industry, first as a technique, identifying two of its main disadvantages and then commenting on the discounted payback method. Evidence showing that the PB acts in a supportive role to the sophisticted DCF methods is presented and the following topics are discussed in detail; PB and owner-manager conflict; as a constraint; in its communication role; as a reciprocal of the internal rate of return; as a proxy for a projects duration; and PB and AMT projects. Following the conclusions, recommendations for further research are proposed.