A higher payback period means it will take longer for a company to cover its initial investment. All else being equal, it’s usually better for a company to have a lower payback period as this typically represents a less risky investment. The quicker a company can recoup its initial investment, the less exposure the company has to a potential loss on the endeavor. The payback period is the amount of time it takes to recover the cost of an investment.
Payback period formula for even cash flow:
Shaun Conrad is a Certified Public Accountant and CPA exam expert with a passion for teaching. After almost a decade of experience in public accounting, he created MyAccountingCourse.com to help people learn accounting & finance, pass the CPA exam, and start their career. Julia Kagan is a financial/consumer journalist and former senior editor, personal finance, of Investopedia.
Step 2: Set Up Your Excel Spreadsheet
You can use the payback period in your own life when making large purchase decisions and consider their opportunity cost. Understanding the way that companies https://team-eng.com/event/nx-design-essentials-training-20-05-19/ calculate their payback period is also helpful to determine their financial viability and whether it makes sense for you to invest in them as part of your portfolio. Knowing the payback period is helpful if there’s a risk of a project ending in the future.
Is the Payback Period the Same Thing As the Breakeven Point?
Company C is planning to undertake a project requiring initial investment of $105 million. The project is expected to generate $25 million https://cowboysjerseysedge.com/free-accounting-software-program-for-new-small-companies.html per year in net cash flows for 7 years. The payback period is calculated by dividing the initial capital outlay of an investment by the annual cash flow.
Rate of Return (RoR): Formula and Calculation Examples
Unlike net present value , profitability index and internal rate of return method, payback method does not take into account the time value of money. A modified variant of this method is the discounted payback method which considers the time value of money. If opening the new stores amounts to an initial investment of http://www.nhkseating.com/employment/about-the-company $400,000 and the expected cash flows from the stores would be $200,000 each year, then the period would be 2 years.
- ✝ To check the rates and terms you may qualify for, SoFi conducts a soft credit pull that will not affect your credit score.
- Although calculating the payback period is useful in financial and capital budgeting, this metric has applications in other industries.
- Most capital budgeting formulas, such as net present value (NPV), internal rate of return (IRR), and discounted cash flow, consider the TVM.
- A general rule to consider when using the discounted payback period is to accept projects that have a payback period that is shorter than the target timeframe.
Unlike other methods of capital budgeting, the payback period ignores the time value of money (TVM). This is the idea that money is worth more today than the same amount in the future because of the earning potential of the present money. There are a variety of ways to calculate a return on investment (ROI) — net present value, internal rate of return, breakeven — but the simplest is payback period. Considering that the payback period is simple and takes a few seconds to calculate, it can be suitable for projects of small investments.