The payback period is the length of time required for an investment to recover its initial cost from net cash inflows. It is a simple capital budgeting technique used to quickly assess liquidity risk — shorter payback periods are generally preferred.
Payback Period = Initial Investment / Annual Cash Inflow [Even cash flows]
For uneven cash flows: accumulate cash flows until they equal the initial investment
For uniform annual cash flows, simply divide the upfront cost by the annual inflow. For uneven cash flows, add each year's inflow cumulatively until you reach the initial investment cost.
Example 1: Machine costs $120,000. Generates $30,000 annual net cash inflow (uniform).
Result: Payback Period = 4 years
Example 2: Project costs $50,000. Cash flows: Year 1: $10K, Year 2: $15K, Year 3: $20K, Year 4: $18K
Result: Payback Period = 3.28 years (approximately 3 years 3 months)
Use our free Payback Period Calculator to skip the manual math.
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