Saving & investing
Payback period: Definition, Formula and Example
The payback period is the time needed for cumulative net cash inflows to recover an initial investment.
Scope: General financial concept; examples are hypothetical.
Other names and related labels: Simple payback; Discounted payback.
How it works
Simple payback uses undiscounted cash flows. Discounted payback first discounts each receipt and therefore usually takes longer at a positive discount rate. Neither measure, by itself, evaluates cash flows after recovery.
For a constant positive annual net inflow: simple payback = initial investment / annual net inflow
Fractional-year interpolation assumes the inflow arrives evenly during that year. If cash arrives only at year end, recovery occurs on a payment date.
Recovering $6,000 with $2,000 a year
Assume identical net cash inflows at each year end.
- End of year 1: $2,000 recovered.
- End of year 2: $4,000 recovered.
- End of year 3: $6,000 recovered.
Simple payback is three years. At a positive discount rate, discounted recovery would be later.
No taxes, changing receipts or terminal value; cash flows are already net of operating costs.
Try these example inputsFast recovery is not the same as high overall value
A project can recover its initial cost quickly and then lose money. A cash-flow stream may also fail to recover within the selected horizon. Do not label an unrecovered investment as having a zero-year payback.
Explore with a calculator
- Payback Period Calculator
Compare simple payback, discounted payback and NPV.
- Business Loan Calculator
Inspect financing costs separately from a project’s operating cash flows.
Sources and checks
Definition and example arithmetic checked . Sources explain the concepts; numerical examples use the assumptions stated above.
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