To calculate the payback period you can use the mathematical formula: Payback Period = Initial investment / Cash flow per year For example, you have invested Rs 1,00,000 with an annual payback of Rs 20,000. Payback Period = 1,00,000/20,000 = 5 years. You may calculate the payback period for uneven cash flows.

How can payback period be used to evaluate potential projects?

Account and fund managers use the payback period to determine whether to go through with an investment. Shorter paybacks mean more attractive investments, while longer payback periods are less desirable. The payback period is calculated by dividing the amount of the investment by the annual cash flow.

What would be the best situation in which to use the payback method?

To assess projects that Require little investment when compared to the size of the company. To assess the value of potential capital or technological improvements. To determine which project of several options is the best investment.

How is simple payback calculated?

To determine how to calculate payback period in practice, you simply divide the initial cash outlay of a project by the amount of net cash inflow that the project generates each year. For the purposes of calculating the payback period formula, you can assume that the net cash inflow is the same each year.

What do you need to know about the Payback method?

Payback method. Under payback method, an investment project is accepted or rejected on the basis of payback period. Payback period means the period of time that a project requires to recover the money invested in it. It is mostly expressed in years.

What is the maximum payback period for a project?

If the payback period of a project is shorter than or equal to the management’s maximum desired payback period, the project is accepted, otherwise rejected. 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.

What are the implications of a shorter payback period?

The implications of this are that the firm may choose investments with shorter payback periods at the expense of profitability. Another issue with the payback period is that it does explicitly discount for the risk and opportunity costs associated with the project.

Why is depreciation ignored in the Payback method?

Depreciation is a non-cash expense and has therefore been ignored while calculating the payback period of the project. According to payback method, the equipment should be purchased because the payback period of the equipment is 2.5 years which is shorter than the maximum desired payback period of 4 years. A D V E R T I S E M E N T