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Wize University Introduction to Finance Textbook > Capital Budgeting

Payback Period

Introduction to Capital BudgetingPrevious Section
Discounted Payback PeriodsNext Section
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The Payback Period

The payback period is the length of time required for an investment to recover its initial outlay in terms of profits or savings.

  • Measures the amount of time it will take to recoup initial investment.
  • Payback period should be less than the cut-off of the investment.
  • Disadvantage: uses only nominal cash flows and does not factor in time value of money and the cost of capital.


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Example: Payback Period

You are considering 5-year investment that will require in initial cash outlay of $40,000. The expected inflows in years 1 through 3 are $10,000; then $12,000 in year 4 and $20,000 in year 5.

What is the payback period?

Practice: Payback Period

A project with an initial after-tax cash outlay of $40,000 is expected to return $6,000 per year forever. What is the payback period?

Round your answer to 2 decimal places
The payback period is
years
Extra Practice
Question 2
A project requires an initial investment of $100,000 and will return $30,000 per year indefinitely. The firm's average cost of capital is 8% and this project is slightly riskier than their usual operations.
Risk premiums:
Question 1
A firm is considering a project with an initial after-tax cash outflow of $5,000 and inflows of $1,000 in year 1, $6,000 in year 2 and $3,000 in year 3. The firm's cost of capital is 6% .
Compute the payback period and discounted payback period for this project.
ABC Company is considering a new project that will require an initial investment of $100,000. The project is expected to generate the following cash flows over the next five years:
Year 1: $30,000 Year 2: $40,000 Year 3: $50,000 Year 4: $40,000 Year 5: $30,000
The required rate of return for this project is 10%.