Definition
Payback period measures how quickly an investment recovers its initial outlay. While simple and intuitive, it ignores the time value of money and cash flows after the payback date. Discounted payback period addresses the time value issue but still ignores post-payback cash flows. Despite limitations, payback remains popular as a quick risk screen.
functions Formula
Payback = Initial Investment / Annual Cash Flow
lightbulb Example
A $200K investment generates $50K annually. Simple payback = 4 years. If the company requires a 3-year payback, this project would be rejected.
verified_user Key Points
- Simple and intuitive risk measure
- Ignores time value of money
- Ignores cash flows after payback period
- Discounted payback adjusts for time value