Payback Period Method

Payback Period Method

See Also:
Bailout Payback Method
Capital Budgeting Methods
NPV vs Payback Method

Payback Period Method

Payback period shows the length of time required to repay the total initial investment through investment cash flows. A project is acceptable if its payback period is shorter than or equal to the cutoff period.

Payback Period Formula

Payback period = Initial investment ÷ Cash flow per year

Calculation

For example, a company invested $20,000 for a project and expected $5,000 cash flow annually.
Payback period = 20,000 / 5,000 = 4
This means that a company can get the initial investment back in 4 years.

Payback Period Advantages and Disadvantages

The shorter the payback period, the better a company is. A long payback means that the investment dollars will be locked up for a long time, hence the project is relatively illiquid, and since the project’s cash flows must be forecast far out into the future, the project is probably quite risky.

Advantages:

Refer to the following advantages:
1. Payback period method is simple and easy to calculate and to apply fro small, repetitive investments.
2. Payback period method takes into account tax and depreciation.

Limitations:

Refer to the following limitations:
1. Payback method ignores cash flows after the pay back period.
2. Payback method ignores the time value of money and risk.
Payback Period Method

ARTICLES YOU MIGHT LIKE

Does your Accounting Department Produce Net Income?

Coaching the Entrepreneur: Learn how to know what you don’t know. How much should I spend on accounting for my company?     I have been in the accounting profession for 32 years, and for the last 6 years, I’ve owned my own consulting firm to assist companies with accounting challenges. There is one common theme that I

Read More »

Is Mexico the New China?

In the wake of the COVID-19 pandemic and escalating tensions with China, American companies are actively seeking alternatives to mitigate their supply chain risks and reduce dependence on Chinese manufacturing. Nearshoring, the process of relocating operations closer to home, has emerged as an explosive opportunity for American and Mexican companies to collaborate like never before.

Read More »

JOIN OUR NEXT SERIES

Financial Leadership Workshop

MARCH 28TH-31ST 2022

THE ART OF THE CFO®

Financial Leadership Workshop

Days
Hours
Min

August 7-10th, 2023

SHARE THIS ARTICLE
WIKI CFO® - Browse hundreds of articles
Skip to content