The payback period measures the time required for an investment to recover its initial cost from the cash inflows generated by the project. It provides a simple and intuitive measure of risk, as shorter payback periods are generally preferred.
To calculate the payback period:
- Identify Cash Inflows and Outflows: List all expected cash flows over the project's lifespan.
- Calculate Cumulative Cash Flow: Sum the cash inflows and outflows for each period to determine the cumulative cash flow.
- Determine Payback Period: Identify the period in which the cumulative cash flow equals or exceeds the initial investment.
The payback period is calculated as:
