AGECON 211 Practical 02: Project Appraisal Using Undiscounted Measures

B.Sc. (Hons.) Agriculture | Semester 3 | AGECON 211 | Practical 02

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Learning objectives

Compute simple payback and accounting rate of return, state their conventions and explain their limitations.

Simple payback

Payback is the time required for cumulative undiscounted net cash inflows to recover initial investment. With equal annual inflows, payback = initial investment ÷ annual net cash inflow. With uneven inflows, use a cumulative cash-flow table.

Worked example

A venture invests ₹1,00,000 at time 0 and receives net cash inflows of ₹30,000, ₹40,000, ₹50,000 and ₹20,000 in years 1–4. Cumulative receipts are ₹30,000, ₹70,000, ₹1,20,000 and ₹1,40,000. After year 2, ₹30,000 remains unrecovered. With uniform receipt through year 3, payback = 2+30,000/50,000 = 2.60 years.

If receipts occur strictly at year-end, recovery occurs at the end of year 3. A fractional payback answer assumes within-year interpolation; state that assumption rather than treating it as an actual receipt date.

Accounting rate of return

ARR uses accounting profit rather than cash flow. Common denominators are original investment and average investment; state which one is used. Suppose asset cost is ₹1,00,000, residual value is ₹20,000 and average annual accounting profit after depreciation is ₹12,000. Simple average investment = (1,00,000+20,000)/2 = ₹60,000. ARR on average investment = 12,000/60,000×100 = 20%. ARR on original investment is 12%.

The average-investment expression assumes a simple pattern of asset-value decline. Where working capital or additional investment is included, follow the exercise convention and explain it. Do not add depreciation back when ARR specifically calls for accounting profit.

Practical procedure

1. Record initial investment and year-wise net cash flows.
2. Prepare cumulative cash flows and locate recovery.
3. Interpolate only under an explicit within-year assumption.
4. Calculate ARR from accounting profit using a declared denominator.
5. Compare results with a stated decision benchmark.
6. Discuss project life, later flows, timing and risk.

Interpretation

Shorter payback can be useful when liquidity exposure is a concern, but it ignores the time value of money and all flows after recovery. ARR depends on accounting treatment and investment conventions. Two projects with equal payback can have very different total benefits, maintenance needs and residual values. Neither measure alone establishes economic superiority.

Worksheet and common errors

Use separate columns for cash flow, cumulative cash flow, depreciation and accounting profit. Do not substitute profit for cash in payback. Include residual receipts and working-capital recovery where the question requires them, and avoid comparing ARR values calculated with different denominators.

Revision and assessment

1. Find payback for ₹80,000 investment and ₹20,000 equal annual inflows.
2. Why can ARR answers differ for the same venture?
3. Does payback capture total profitability?

Answer guide

1. Four years.
2. They may use different profit measures or original versus average investment.
3. No. It ignores timing and cash flows after recovery.

Independent English study notes for the topics listed in the AGECON 211 course index. Consult your prescribed university syllabus for official course wording and assessment requirements. Numerical cases are hypothetical learning examples.