What is the payback period?
The payback period is defined as the length of the time period required for recouping the funds spent on investment. It is one of the most simplest investment appraisal techniques. The time value of money is not considered in the payback period. It is used to measure the time taken for something to pay for itself. The shorter payback periods are advantageous than the longer payback periods. The calculations used for estimating the payback period is known as the payback method. This method is used to calculate the time required to earn back the amount sustained in the investment through the consecutive cash inflows.
Payback period = initial investment / cash flow per year
Advantages and disadvantages of payback period:
- It is very easy to calculate.
- It can be used to measure the risk of inherent in the investments. The cash flow that occurs later the investment life is not certain. It provides an indication of how certain the investment cash inflows are.
- For individuals or companies facing liquidity problems will help to provide a good ranking of investments that would return the money early.
- The time value of money is not taken into account.
- It doesn’t consider the cash flow occurred after the payback period.
Discounted payback period:
The discounted payback period is a capital budgeting to estimate the profitability of investment. The time period took for break-even point from the initial cash outflow by discounting the future cash flow and identifying the time value of money. DPP include investment amount, discount rate and cash flow per year.
DPP = -In (1- investment amount * discount rate/ cash flow per flow) / In (1+rate)
The cash flow is defined as the inflow and outflow of cash of an individual or organization. The positive cash flow has occurred during the investment period such as accounts receivable, revenue and increased liquid assets. The negative cash flow like payments of expenses, rents and taxes etc.
Discounted cash flow:
The future cash flow is estimated and discounted by the user cost of the principal to give the present values. The present value estimations are used to calculate the potential for investments.
The components included in the payback period calculator:
Fixed cash flow:
- Initial investment: The amount that is invested initially.
- Cash flow: The cash inflow and cash outflow.
- Number of years: The numbers of years the investment made.
- Discount rate: The discounted amount in percentage.
Irregular cash flow each year:
- The cash flow each year.
This calculator can be used to calculate the payback period, discounted payback period and it includes discounted rate and cash flows.