payback period

Payback Period

The length of time required to recover the cost of an investment.

Calculated as:

Notes:

All other things being equal, the better investment is the one with the shorter payback period.

For example, if a project cost $100,000 and was expected to return $20,000 annually, the payback period would be $100,000 / $20,000, or 5 years.

There are two main problems with the payback period method:

1) It ignores any benefits that occur after the payback period, and so does not measure profitability
2) It ignores the time value of money

Because of these two reasons, other methods of capital budgeting like NPV, IRR, or DCF are generally preferred.

See also: Capital Budgeting, Cost of Capital, Discounted Cash Flow (DCF), Internal Rate of Return (IRR), Net Present Value (NPV)

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payback period

1. The length of time needed for an investment's net cash receipts to cover completely the initial outlay expended in acquiring the investment.

2. The number of years the higher interest income from a convertible bond (compared with the dividend income from an equivalent investment in the underlying common stock) must persist to make up for the amount above conversion value paid for the convertible. Also called premium recovery period.