What is Payback Period
Payback period is a financial metric that measures the time required for an investment to recover its initial cost through the cash flows it generates. This crucial financial indicator helps investors and businesses evaluate the feasibility and risk of their investments by determining how long it will take to break even.
There are two main types of payback periods:
- Regular Payback Period: The simple time required to recover the initial investment without considering the time value of money
- Discounted Payback Period: A more sophisticated measure that accounts for the time value of money by applying a discount rate to future cash flows
How to Calculate Investment Payback Period
Step 1: Enter your initial investment amount in the designated field. This represents the total upfront cost of your investment project.
Step 2: Select either “Fixed Cash Flow” or “Irregular Cash Flow” based on your investment’s expected returns pattern.
Step 3: For fixed cash flows, input the expected annual cash flow amount. For irregular cash flows, enter the expected cash flow for each year separately.
Step 4: Input your desired discount rate, which represents the time value of money or required rate of return. The default is set to 5%.
Step 5: Click the “Calculate” button to obtain both the regular and discounted payback periods.
Step 6: Review the results and explanation provided. The calculator will show you both the regular payback period and the discounted payback period, allowing you to make a more informed investment decision.
Step 7: For irregular cash flows, use the “Add Year” button to include additional years of projected cash flows if needed for your analysis.