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Payback Period Calculation Examples Meaning

Payback period is that time in which the amount of money that was originally invested in a project is expected to be recovered from the cash inflows generated by that project.
The formula to calculate payback period of a project depends on whether the cash flow per period from the project is even or uneven. The formula to calculate payback period when cash flows are even
Payback Period = Initial Investment/Cash Inflow per Period
When cash inflows are uneven, we need to calculate the cumulative net cash flow for each period and then use the following formula for payback period
Payback Period = years before fully recovery + (unrecovered cost at the start of the year/
Cashflow during the year)

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Payback Period Calculation Examples Explanation

Let’s understand the concept in both the situations
Example 1: When Cash Flows are even
Initial investment in a project $100000. The project is expected to generate $25000 per year for 7 years. Calculate the payback period of the project.
Payback Period = Initial Investment ÷ Annual Cash Flow = $100000 ÷ $25000 = 4years
Example 2: Uneven Cash Flows
Initial investment in a project is suppose $50000 and is expected to generate $10000 in Year 1, $13000 in Year 2, $16000 in year 3, $19000 in Year 4 and $22000in Year 5. Calculate the payback value of the project.
Year Cash Flows in $ Cumulative Cash Flow
0 (50000) (50000)
1 10000 (40000)
2 13000 (27000)
3 16000 (11000)
4 19000 8000
5 22000 30000
Payback Period
= 3 + (1-$11| ÷ $19)
= 3 + ($11 ÷ $19)
≈ 3 + 0.58
≈ 3.58 years
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