Payback Period

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Recovering the costs of investments. Explanation of Payback Period (PP).


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What is the Payback Period? Description

The Payback Period is perhaps the simplest method of looking at one or more investment projects or ideas. The Payback Period method focuses on recovering the cost of investments. The Payback Period represents the amount of time that it takes for a capital budgeting project to recover its initial cost.

Calculation of Payback Period. Formula

 Payback Period recovering the costs of investmentsCalculating the Payback Period can be done in the following way:

           The Costs of Project / Investment

PP =   --------------------------------------------------

           Annual Cash Inflows

The Payback Period concept holds that all other things being equal, the better investment is the one with the shorter payback period.

Example of Payback Period calculation

For example, take a project costing a total of $200,000. The expected returns of the project amount to $40,000 annually. The Payback Period would be $200,000 : $40,000 = 5 years.

Benefits of Payback Period

The Payback Period certainly has the virtue of being easy to compute and easy to understand. But that simplicity carries weaknesses with it.

Limitations of the Payback Period

There are at least two major problems associated with the Payback Period model:

1) PP ignores any benefits that occur after the Payback Period. It does not measure total incomes.
2) PP ignores the time value of money.

Because of these two reasons, more professional methods of Capital budgeting are advisable.

Payback Period Forum
  Payback Period Calculation for Equipment Replacement
How to calculate payback period when a company is investing in new equipment to replace old ones. For example an airline is investing in ground power units for aircraft engine start up. The new equipment will not bring any revenues.
Thanks for y...
  How to Calculate the Payback Period with a Spreadsheet?
I understand how everyone has calculataed the payback period from the other posts but my questions is this:
Most spreadsheets do not have a built-in formula to calculate the payback period so how would you incorporate your own to get the answer ...
  Calculating Payback Period without Annual Cash Flows
What if I don't have annual cash flows, should I take the net cash inflows?...

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Best Practices - Payback Period Premium
  Calculation of Pay back period
How do we calculate payback period when the returns / cashflows are different each year?...

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Payback Period Diagram

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Usage (application): Recovering the costs of investments

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Compare with Payback Period: Net Present Value  |  Internal Rate of Return  |  Discounted Cash Flow

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