| 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. |
An estimate of the time that will be necessary for an investor to recoup the initial investment.It is used to compare investments that might have different initial capital requirements.
What Does Payback Period Mean?
The length of time it takes to recover the cost of an investment. It is calculated as shown here:
Investopedia explains Payback Period
All other things being equal, the better investment is the one with the shorter payback period. For example, if a project costs $100,000 and is expected to return $20,000 annually, the payback period will be $100,000/$20,000, or five years. There are two main deficiencies with the payback period method: (1) It ignores any benefits that occur after the payback period and therefore does not measure profitability. (2) It ignores the time value of money. Because of these factors, other methods of capital budgeting, such as net present value, internal rate of return, and discounted cash flow, generally are preferred.
Related Terms:
• Cost of Capital
• Discounted Cash Flow—DCF
• Internal Rate of Return—IRR
• Opportunity Cost
• Return on Investment
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