The Payback Period Calculator helps you compute the length of time it takes for an investment to generate enough cash flow to recover its initial cost.
The initial investment: the outflow of money required by the investment today (e.g. machinery or a plant)
The cash flow: the inflow of money generated for each subsequent period (e.g. gross margin generated by products sold)
Simply divide the initial investment by the periodic cash inflow to determine the number of periods, usually years, it will take for the investment to "pay back" its initial cost, as follows
Payback period = Initial investment / Cash flow
For simplicity’s sake and to better illustrate the concept, we assume that all subsequent cash flows are equal.
However, in reality, with economies of scale and learning curves in place, cash flows are often different from period to period. In that case, you can use the cumulative cash flow to quickly compute the payback period as follows:
Compute the cumulative cash flow for each subsequent year, together with the remaining capital, namely the initial investment minus the cumulative cash flow
The year in which the cash flow is bigger than the previous year remaining capital represents the unit of your payback period, namely the Payback year.
Finally, you need to determine the Year pro-quota, as the additional portion of the year it takes to zero the remaining capital, taking the ratio between the remaining capital and the cash flow corresponding to the payback year as follows:
Year pro-quota = Remaining capital
Payback period = Payback Year + Year pro-quota
A shorter payback period is generally preferable as it means that the investment will generate returns more quickly. Payback period analysis is important for businesses as it helps them to make informed decisions about investments, assess risks and evaluate the feasibility of different projects. It can be used in conjunction with other methods, such as Net Present Value (NPV) analysis, which takes into account the time value of money and helps businesses to compare the profitability of different investments by discounting future cash flows to their present value. By considering both the payback period and NPV, businesses can make better investment decisions and maximize their returns.
As CF3 > Remaining capital(year 2)
Payback year = 3
Year pro-quota = 20,000$
/ 50,000$ = 0.4
Payback period = 3 + 0.4 = 3.4 years