Table of Contents
What is Payback period
Payback period is the amount of time it takes for a project to generate net cash flows equal to the initial capital invested to implement the project.
The payback period method is the Payback period method. The payback period method is based on the payback period for project selection.
How to determine the payback period?
To determine the time to recover investment capital can be divided into two cases:
– Case 1: If the investment project generates a monetary series of regular annual income, the time to recover the investment capital (investment) is determined by the formula:
Investment recovery period (years) = Initial investment / Annual net cash flow of the investment project
– Case 2: If the investment project creates an unstable monetary chain over the years. The payback period of the investment is determined in the following way:
+ Determine the number of years to recover investment capital by calculating the amount of investment remaining to be recovered at the end of the year in the following order:
Amount of investment to be recovered at the end of year t = Amount of uncollected investment at the end of year (t-1) – Net cash flow of investment project in year t
+ When the amount of investment remaining to be recovered at the end of a certain year is less than the net cash flow of the investment project in the next year, it is necessary to determine the time (number of months) to recover the remaining investment in the next year.
Project A has an investment capital of 150 million PHP (one-time capital investment). Expected income (including depreciation and profit after tax) in future years is as follows:
The payback period of project A’s investment is calculated as follows:
|Year||Net cash flow of Investment (PHP million)||Amount still to be recovered at the end of the year (PHP million)||Cumulative recovery period (years)|
|3||50||40/(50:12) = 9,6 months|
Time to recover investment capital of project A:
TA = 2 + (40/50) x 12 = 2 years and 9.6 months
Method content of payback period
– Eliminate projects with prolonged construction time that do not meet the requirements of the project
In order to simplify the calculation, first of all, it is necessary to eliminate investment projects (investment projects) that have a long construction time and do not meet the requirements of enterprises; then put projects with similar construction time into one category.
– Determine the payback period of each investment project.
– Evaluation of project selection
On the basis of the payback time of each project, the enterprise will choose the project with the investment recovery time suitable to the capital recovery time that the enterprise intends.
Accordingly, projects with payback periods longer than the standard payback period will be rejected. If the projects are mutually exclusive, the project with the shortest payback period is usually chosen.
Advantages of payback period
– Simple, easy to calculate
– Suitable for the consideration of small and medium-sized investment projects, with a strategy of quick capital recovery, increasing capital turnover.
Disadvantages of payback period
– The payback period method focuses on considering short-term benefits rather than long-term benefits.
– Project review does not take into account the time value of money, in other words, it does not consider the time at which revenues and receipts are generated. Coins obtained at different times are valued equally.