payback period

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Payback period

In project evaluation and capital budgeting, the payback period estimates the time required to recover the principal amount of an investment.  Because the payback period method ignores any benefits that occur after the investment is repaid and the time value of money, other methods of investment analysis are often preferred. See: Internal rate of return (IRR), Discounted cash flow (DCF), and Net present value (NPV)
Copyright © 2012, Campbell R. Harvey. All Rights Reserved.

Payback Period

The time between the first payment on a loan and its maturity. For example, if one takes out a student loan with a payback period of 10 years, the full amount of the loan is due 10 years after the first payment, which occurs on an agreed-upon date. Over the course of the payback period, a borrower must either pay back the loan with his/her own funds or take out a different loan to pay off the first. It is also called the premium recovery period. See also: Refinancing.
Farlex Financial Dictionary. © 2012 Farlex, Inc. All Rights Reserved

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.
Wall Street Words: An A to Z Guide to Investment Terms for Today's Investor by David L. Scott. Copyright © 2003 by Houghton Mifflin Company. Published by Houghton Mifflin Company. All rights reserved. All rights reserved.

payback period

a criterion used in INVESTMENT APPRAISAL to evaluate the desirability of an INVESTMENT project. Payback calculations involve measuring the CASH FLOWS associated with a project and indicate how long it takes for an investment to generate sufficient cash to recover in full its original capital outlay. For example, if a machine costs £5,000 to purchase at the start of year 1, then generates net cash inflows from the sale of products made by the machine of £5,000 in year 1 and £3,000 in year 2 then it would recoup the initial cash outlay in the first year. If a firm's target payback period for new investment projects was, say, two years or less, then this particular project would be undertaken.

Whether or not the machine pays back its initial outlay in one year depends upon how accurate the future estimates of sales volumes, selling prices, materials costs etc. turn out to be. Since all investments involve assessments of future re-venues and costs they are all subject to a degree of uncertainty. This problem, in part, can be handled by undertaking sensitivity analysis, by making not one but three estimates for each item of project cost or revenue (‘optimistic’, ‘most likely’, ‘pessimistic’) to indicate the range of possible outcomes.

Collins Dictionary of Business, 3rd ed. © 2002, 2005 C Pass, B Lowes, A Pendleton, L Chadwick, D O’Reilly and M Afferson

payback period


payback method

the period it takes for an INVESTMENT to generate sufficient cash to recover in full its original capital outlay. For example, a machine that cost £1,000 and generated a net cash inflow of £250 per year would have a payback period of four years. See also DISCOUNTED CASH FLOW, INVESTMENT APPRAISAL.
Collins Dictionary of Economics, 4th ed. © C. Pass, B. Lowes, L. Davies 2005

payback 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.

The Complete Real Estate Encyclopedia by Denise L. Evans, JD & O. William Evans, JD. Copyright © 2007 by The McGraw-Hill Companies, Inc.
References in periodicals archive ?
It is interesting to note that the second most popular technique is the payback method. These results agree with the findings of previous studies and show a continual shift toward models that incorporate present value techniques.
The payback method does this very explicitly by requiring very short payback periods, typically two to three years.
There are three commonly used methods of evaluating capital expenditures: the payback method (PB), the internal rate of return method (IRR), and the net present value approach (NPV).
If we use the traditional payback method without considering the time value of money, the payback period will be $2000/$17.28 or 115.74 months.
For example 86 per cent of those organizations which "often" or "always" used the payback method combined it with a discounting method and 94 per [TABULAR DATA FOR TABLE I OMITTED] [TABULAR DATA FOR TABLE II OMITTED] [TABULAR DATA FOR TABLE III OMITTED] cent of those firms "often"/"always" using the accounting rate of return also combined it with a discounting method.
Table 3 reveals that 67.6 per cent of firms in the sample claimed to use the payback method, falling to 33.8 per cent for the accounting rate of return (ARR) method - with only 23.9 per cent stating that they used the more sophisticated discounted cash flow (DCF) techniques; that is, the net present value (NPV) and internal rate of return (IRR) methods.
The tried and true way of measuring the wisdom of investments in new equipment is the simple payback method. It's easy to understand and involves calculating the time needed to recover the initial dollars invested in a project through savings.
Most financial experts agree the most appropriate way to evaluate cost effectiveness is by using the net present value method rather than the internal rate of return or the payback method of analysis.(1-3)
The payback method is an ad hoe rule that looks at how quickly a project pays back the initial investment.
The accuracy of the simply payback method worsens as time periods become longer because the method does not take into account either the time value of money or the service life of the project.