payback period

(noun)

the amount of time required for the return on an investment to return the sum of the original investment

Related Terms

Examples of payback period in the following topics:

  • Calculating the Payback Period

    • To calculate a more exact payback period: Payback Period = Amount to be initially invested / Estimated Annual Net Cash Inflow.
    • Payback period is usually expressed in years.
    • Payback period method does not take into account the time value of money.
    • The modified payback period algorithm may be applied then.
    • To be more detailed, the payback period would be: 4 + 2/7 = 4.29 year.

  • Advantages of the Payback Method

    • All else being equal, shorter payback periods are preferable to longer payback periods.
    • The payback period is an effective measure of investment risk.
    • The project with a shortest payback period has less risk than with the project with longer payback period.
    • Payback period method is suitable for projects of small investments.
    • The business is more likely to use payback period to choose a project.

  • Disadvantages of the Payback Method

    • Payback period analysis ignores the time value of money and the value of cash flows in future periods.
    • An implicit assumption in the use of payback period is that returns to the investment continue after the payback period.
    • Payback period does not specify any required comparison to other investments or even to not making an investment.
    • Payback also ignores the cash flows beyond the payback period, thereby ignoring the profitability of the project.
    • The modified payback period algorithm may be applied then.

  • Discounted Payback

    • Discounted payback period is the amount of time to cover the cost, by adding positive discounted cash flow coming from the profits of the project.
    • Payback period in capital budgeting refers to the period of time required for the return on an investment to "repay" the sum of the original investment.
    • Compared to payback period, the discounted payback period takes the time value of money into consideration.
    • An implicit assumption in the use of payback period is that returns to the investment continue after the payback period.
    • Payback period does not specify any required comparison to other investments or even to not making an investment.

  • Defining the Payback Method

    • A $1000 investment which returned $500 per year would have a two year payback period.
    • In capital budgeting, the payback period refers to the period of time required for the return on an investment to "repay" the sum of the original investment.
    • As a stand-alone tool to compare an investment, the payback method has no explicit criteria for decision-making except, perhaps, that the payback period should be less than infinity.
    • An implicit assumption in the use of the payback method is that returns to the investment continue after the payback period.
    • The payback period is usually expressed in years.

  • Defining Capital Budgeting

    • Payback period: For example, a $1000 investment which returned $500 per year would have a two year payback period.
    • Payback period in capital budgeting refers to the period of time required for the return on an investment to "repay" the sum of the original investment.
    • Payback period intuitively measures how long something takes to "pay for itself. " All else being equal, shorter payback periods are preferable to longer payback periods.
    • The payback period is considered a method of analysis with serious limitations and qualifications for its use, because it does not account for the time value of money, risk, financing, or other important considerations, such as the opportunity cost.
    • Simplified and hybrid methods are used as well, such as payback period and discounted payback period.

  • Ranking Investment Proposals

    • Several methods are commonly used to rank investment proposals, including NPV, IRR, PI, payback period, and ARR.
    • Payback period intuitively measures how long something takes to "pay for itself. " All else being equal, shorter payback periods are preferable to longer payback periods.
    • Payback period is widely used because of its ease of use despite the recognized limitations: The time value of money is not taken into account.

  • Advantages of the IRR Method

    • Compared to payback period method, IRR takes into account the time value of money.

  • Calculating Values for Fractional Time Periods

    • Up to this point, we have implicitly assumed that the number of periods in question matches to a multiple of the compounding period.
    • Compounding periods can be any length of time, and the length of the period affects the rate at which interest accrues.
    • In this case, you need to find the amount of money that is actually in the account, so you round the number of periods down to the nearest whole number (assuming one period is the same as a compounding period; if not, round down to the nearest compounding period).
    • Even if interest compounds every period, and you are asked to find the balance at the 6.9999th period, you need to round down to 6.
    • The last time the account actually accrued interest was at period 6; the interest for period 7 has not yet been paid.

  • Number of Periods

    • In , nrepresents the number of periods.
    • A period is just a general term for a length of time.
    • If one period is one month, the discount rate must be X% per month.
    • In compound interest, the interest in one period is also paid on all interest accrued in previous periods.
    • Define what a period is in terms of present value calculations