Why to analyse the period when Owner's capital will be recovered?
Investors are interested first in avoiding risk of not recovering their investment, then in the firm's liquidity and solvency and then in profitability. One important measure of risk mitigation is the speed by which Initial Capital can be recovered or the time needed for investors to have their capital back.
Payback defines the time required to recover the original investment and indicates how long it will take for equity to be equal to the original investment. Investors are interested in knowing the answer to: when the investment will "pay itself back"?
The payback period intuitively measures how long something takes to "pay for itself"; shorter payback periods are preferable to longer payback periods (all else being equal).
Despite recognised shortcomings, mainly not showing why how the recovery of capital has occurred, Payback Period is widely used as an indicator of the quality of the investment.
The simulation methodology is based in comparing the baseline scenario with the target scenario, then management has to analyse the action to be taken to reach the objective, such as increase of capital, increase of market share, increase in unit prices, decrease of costs, and increase in bank borrowing. Finally implement the action.
We will explain the theoretical foundation to analyse each action followed by the use of the Business Game, so that a theoretical and a practical approach are provided.
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