# Payback period analysis

## Discounted payback period

Thus, its use is more at the tactical level than at the strategic level. The formula for the payback method is simplistic: Divide the cash outlay which is assumed to occur entirely at the beginning of the project by the amount of net cash inflow generated by the project per year which is assumed to be the same in every year. Gradually over time, it might generate returns. So in this row, I have calculated the cumulative cash flow for year 0, or present time, the cumulative cash flow equals the capital cost at present time. The time value of money is a concept that assigns a value to this opportunity cost. An investment with a shorter payback period is considered to be better, since the investor's initial outlay is at risk for a shorter period of time. Individual asset orientation. What are the shortcomings of this method?

I could also refer to the cells here, but be careful when you're referring to these cells-- this has a negative sign, so you need to add a negative sign to make sure the result is going to positive. Management will set an acceptable payback period for individual investments based on whether the management is risk averse or risk taking.

Since cash flows that occur later in a project's life are considered more uncertain, payback period provides an indication of how certain the project cash inflows are.

Purpose[ edit ] Payback period as a tool of analysis is often used because it is easy to apply and easy to understand for most individuals, regardless of academic training or field of endeavor.

So lets use an Excel spreadsheet to calculate the payback rate for this example.

This difference equals this one, so I can either use this number or I can calculate the difference. It is based on a very simple need to get back at least how much has been spent. So I will say minus this, divided by this number minus this number.

The payback period, though, disregards the time value of money.

The payback period is determined by dividing the cost of the capital investment by the projected annual cash inflows resulting from the investment.

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