In one line
A business case asks for money now against cash it should earn later. Payback is how long the extra cash takes to repay what went in; net present value (NPV) adds up that cash over the years, discounted for time, less the cost.
What it does
- Start with the change the project makes: the cash the business earns with it, against the same business without it. Everything else, including the market's luck, should be the same on both sides.
- Payback divides the money committed by the extra cash it brings in a year. It is simple and favours quick returns, but it ignores what happens after payback and the time value of money.
- NPV discounts each year's extra cash at the cost of capital and subtracts the investment. Above zero, the project earns more than that rate. Countermove's board uses 8% a year over five years, and adds depreciation back because it is not cash.
- Both rest on a forecast of the extra cash. Run the case in many worlds and payback becomes a range, so the question becomes the odds it clears the hurdle. Cases also tend to be optimistic: Lovallo and Kahneman (2003) suggest checking them against how similar projects actually turned out.
Business and brand
Impact on the businessP&L, cash, share price
- Surveyed finance chiefs use payback almost as often as NPV, mostly as a rough check on risk (Graham and Harvey, 2001).
- A project that adds sales can still lower net income for years if it adds interest, depreciation and overheads, as an acquisition bought with debt does.
- Money spent on a project is not there to absorb a shock: cash and borrowing are part of the case.
Impact on the brandMemory, loyalty, pricing power
- Cost savings, like a new production line, repay in cash; brand projects, like a better recipe, repay partly in quality and memory that a five-year cash view only partly sees.
- An acquired brand brings buyers and listings, but its value depends on keeping what made it grow.
- Cutting brand support to make a case's numbers work moves the cost into next year's share.
Try it
Test a business case in thirty worlds
At the mid-year board meeting Brightwater can table one of three cases. Pick one and a payback hurdle. Each dot is one world, with the project against without it; the board's card averages the desk's three forecast worlds.
Own more of production and cut unit costs by about 12%. Costs €22m from cash.
Payback in years, one dot per world: the money committed over the extra cash a year (net income with depreciation added back), each world with the project against the same world without it. Paybacks over 10 years sit at the right edge.
Notice: The board's card averages three worlds: payback 3.5 years, NPV +€0.2m. Across 30 worlds the middle world pays back in 4.1 years and 26 of 30 take longer than the card says. 10 of 30 (33%) pay back within your 4-year hurdle, and 4 of 30 have a positive NPV at 8%.
Runs Countermove's full game in thirty numbered worlds, each with and without the case, using the board's own sums: 8% a year over five years, depreciation added back.
Sources
- Graham & Harvey (2001), Journal of Financial Economics: the theory and practice of corporate finance, evidence from the field
- Lovallo & Kahneman (2003), Harvard Business Review: delusions of success
- Hertz (1964), Harvard Business Review: risk analysis in capital investment
- Flyvbjerg (2006), Project Management Journal: from Nobel Prize to project management, getting risks right