# Payback period analysis

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

So again, as you can see here, this is the discounted payback period-- it is 4. It works very well for small projects and for those that have consistent cash flows each year. Just because a project has a short payback period does not mean that it is profitable. So divided by this difference, which is going to beis going to give us the fraction of the payback period.

This formula ignores values that arise after the payback period has been reached. Then the cumulative positive cash flows are determined for each period.

And obviously, the earlier-- the shorter-- the payback period is better for the investor. So discounted payback period equals 4 plus a fraction. One analysis tool used to evaluate proposed capital expenditure investments is the payback period. Payback period is the earliest time that an investor can recover his or her investment-- his capital cost.

And it can be calculated from the beginning of the project or from the start of the production. For example, if a company wants to recoup the cost of a machine within 5 years of purchase, the maximum desired payback period of the company would be 5 years.

Alternative measures of "return" preferred by economists are net present value and internal rate of return. Advertisement Use of Payback Period Formula There are a few drawbacks to the payback period formula that may warrant one to consider using another method of determining whether to invest.

It is reflecting the time that the investor can get his or her money back. Profitability While the payback period shows us how long it takes for the return of investment, it does not show what the return on investment is. They payback method is a handy tool to use as an initial evaluation of different projects.

Advantages The most significant advantage of the payback method is its simplicity. This analysis method is particularly helpful for smaller firms that need the liquidity provided by a capital investment with a short payback period. Neglects cash flows received after payback period: Based solely on the payback period method, the second project is a better investment.

The inflow and outflow of cash associated with the new equipment is given below: And we can apply these to the other cells, and we can calculate the cumulative cash flow for other years similarly.

First step is calculating the cumulative cash flow.Payback period is the time required for positive project cash flow to recover negative project cash flow from the acquisition and/or development years. Payback can be calculated either from the start of a project or from the start of production.

Payback period is commonly calculated based on undiscounted cash flow, but it also can be calculated for Discounted Cash Flow with a specified minimum. In capital budgeting, the payback period is the selection criteria, or deciding factor, that most businesses rely on to choose among potential capital projects.

Small businesses and large alike tend to focus on projects with a likelihood of faster, more profitable payback. Analysts consider project cash flows, initial investment, and other factors to calculate a capital project's payback period. The payback period formula is used to determine the length of time it will take to recoup the initial amount invested on a project or investment.

What is the Payback Period? The Payback Period shows how long it takes for a business to recoup its investment. This type of analysis allows firms to compare alternative investment opportunities and decide on a project that returns its investment in the shortest time, if that criteria is important to them.

Jun 29,  · The payback period is therefore expressed this way: Initial investment/cash flow per year = \$,/\$50, - 3 years payback. Advantages The. The total cash flows over the five-year period are projected to be \$2,, which is an average of \$, per year.

When divided into the \$1, original investment, this results in .

Payback period analysis
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