Payback Period

The payback period is the time it takes for cumulative cash inflows to recover the initial investment.

Definition

Non-discounted payback sums raw cash flows; discounted payback uses present values to reflect time value of money.

Example (Non-discounted)

Initial outlay $100,000; annual inflows: $35,000, $40,000, $30,000.

• End of year 1 cumulative = 35,000
• End of year 2 cumulative = 75,000
• End of year 3 cumulative = 105,000 → payback occurs during year 3

Fraction of year 3 needed: (100,000 − 75,000) / 30,000 = 0.83 years; payback ≈ 2.83 years.

Step-by-Step

1. List initial outlay and sequence of inflows.
2. Compute cumulative totals until they exceed the outlay.
3. Interpolate within the crossover period for fractional years.
4. For discounted payback, first discount each inflow then repeat.

Considerations

• Ignores cash flows after payback; use NPV/IRR for value creation.
• Discounted payback accounts for time value but is more conservative.
• Use with liquidity constraints or risk screening, not as a sole criterion.