How to Calculate the Payback Period

The payback period measures the length of time required to recover the amount of initial investment. It is computed simply by dividing the initial investment by the cash inflows through increased revenues or cost savings. For investors, it is a key financial ratio to measure whether the investment is profitable or feasible. The shorter the payback period, the less risky the project is and the greater the liquidity.

In cases where the cash inflows are not even, the payback period is then calculated by trial and error, then the result would be to choose the answer with the shortest payback period. The advantages of using the payback period method of evaluating the feasibility of a project are:

• Simple to calculate and easy to understand

• Easy to explain to any reader

• Handles investment risk effectively

Of course, there are shortcomings for using the payback period which are:

• Doesn’t recognize the time value of money

• Focuses on short-term gains

• Ignores the impact of cash inflows received after the payback period

Essentially, the cash flows after payback period determine the profitability of an investment, without properly calculating that, there would be a loss of opportunity that one can take after the declared payback period. But overall, the payback period is a great and simple financial ratio to help any investor to consider an investment.

To help you better understand how to calculate the payback period and add it in a project financial model, you can read more here Payback Period Example Models. Aside from learning about how to calculate payback period, you can also download payback period example model templates at eFinancialModels.

The payback period example models are made by financial modeling experts with a wide-range of industry know-how. You can use the model templates as a base to start with when building your own financial model for either a project or an investment, to help you determine whether it is profitable and feasible.

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Created on Apr 2nd 2020 02:01. Viewed 359 times.

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