A) Simple payback
| Cash flows (£000s) | Proposal 1 | Proposal 2 | Proposal 3 | Proposal 4 |
| Year 0 | -£120 | -£95 | -£80 | -£160 |
| Year 1 | £80 | £10 | £30 | £30 |
| Year 2 | £40 | £40 | £40 | £50 |
| Year 3 | £40 | £40 | £30 | £90 |
| Year 4 | £20 | £60 | £30 | £80 |
| Year 5 | £40 | £50 | £20 | £60 |
Year 0 is the initial investment
Proposal 1 will be paid back in 2 years.
Proposal 2 costs £95
Year 3 £5 left to pay back
5(amount needed for investment to be paid back)/60 (year 4 return) x 12 (number of months in a year) = 0.9 rounded up = 1month. Total payback time = 3 years and 1 month
Proposal 4
80/90 x 12 = 10.6 = 2 years and 11 months payback time
B) Average rate of return
Total net profit/number of years/initial cost x 100
Proposal 3
£70/5/80×100 = 17.5%
Proposal 4
18.75%
C) Discounted cash flow (net present value)
| Cash flows (£000s) | Proposal 1 | Discount table 20% | Present value |
| Year 0 | -£120 | 1.00 | -£120,000 |
| Year 1 | £80,000 | 0.80 | 64,000 |
| Year 2 | £40,000 | 0.64 | 25,600 |
| Year 3 | £40,000 | 0.51 | 20,400 |
| Year 4 | £20,000 | 0.41 | 8,200 |
| Year 5 | £40,000 | 0.33 | 13,200 |
| Total | 11,400 | ||
Makes up for the interest that could have been earned if the business put the money in a bank.
Times the each year of the proposal by the discount figure
If the net present value is positive then the project should go ahead.
E) Limitations of these techniques
- Complicated – May be difficult for the user to make/understand.
- Difficult to select most appropriate discount rate – If the rate is set too high then it may reduce the profitability of the project thus leading to the proposal being rejected.
- NPV very sensitive to initial investment