How To Compute Payback Period
Payback Period
The payback period shows how long it takes to recover its investment. It is used to calculate the length of time required to earn back the expense acquired in the investments through the successive cash inflows.
The decision criterion in payback period:
• The shorter period, the better
• The longer period, the worse
The decision criterion in payback period:
• The shorter period, the better
• The longer period, the worse
Payback Period (Even Cash Inflows)
Formula:
Payback period = Cost of investment / Net Cash Inflows
Example:
Problem 1
Red is considering the purchase of a xerox machine that cost P 35,000 and which will generate P 17,500 per year of net cash flow. Compute the payback period.
Example:
Problem 1
Red is considering the purchase of a xerox machine that cost P 35,000 and which will generate P 17,500 per year of net cash flow. Compute the payback period.
Solution 1
Payback period = P35,000 / P17,500 = 2.0 years
Therefore, the payback period for this capital investment is 2.0 years.
Problem 2
Rose project requires an investment of P 800,000 with 5 years useful life, no salvage value, and uses straight line method of depreciation. Here are the other data:
Expected sales revenue P 2,500,000
Out-of-pocket costs 1,600,000
Tax rate 30%
Compute the payback period.
Solution 2
First, determine the net cash inflows.
Second, compute the payback period
Cost of Investment = 800,000
Net Cash Inflows = 678,000 Payback period = 800,000 / 678,000 = 1.18 yrs
Therefore, the payback period for this capital investment is 1.18 years.
Therefore, the payback period for this capital investment is 2.0 years.
Problem 2
Rose project requires an investment of P 800,000 with 5 years useful life, no salvage value, and uses straight line method of depreciation. Here are the other data:
Expected sales revenue P 2,500,000
Out-of-pocket costs 1,600,000
Tax rate 30%
Compute the payback period.
Solution 2
First, determine the net cash inflows.
Sales P 2,500,000
Less:Pocket costs (1,600,000)
Deprection expense
(800,000 / 5 yrs.) (160,000)
Profit Before Interest and Taxes P 740,000
Less: Tax rate ( 30% )
(PBIT x 30%) (222,000)
Profit P 518,000
Add: Depreciation expense 160,000
Net Cash Inflows P 678,000
Second, compute the payback period
Cost of Investment = 800,000
Net Cash Inflows = 678,000 Payback period = 800,000 / 678,000 = 1.18 yrs
Therefore, the payback period for this capital investment is 1.18 years.
Payback Period (Uneven Cash Inflows)
Formula:
Payback period = Years before full recovery + ( Unrecovered cost at the start of the year / Cash Flow during the year)
Example:
Problem 3
Rose will have an investment of P 200,000 is expected to generate the following cash inflows in five years:
Year 1 - P 90,000
Year 2 - P 70,000
Year 3 - P 80,000
Year 4 - P 60,000
Year 5 - P 40,000
Solution 3
Therefore, the payback period for this capital investment is 2.05 years.
Formula:
Payback period = Years before full recovery + ( Unrecovered cost at the start of the year / Cash Flow during the year)
Example:
Problem 3
Rose will have an investment of P 200,000 is expected to generate the following cash inflows in five years:
Year 1 - P 90,000
Year 2 - P 70,000
Year 3 - P 80,000
Year 4 - P 60,000
Year 5 - P 40,000
Solution 3
Unrecovered cost = 200,000 - 160,000 = 40,000
Cash Flow during the year = 80,000 (Year 3)
Years before full recovery = 2 years (Year 1 & Year 2)
Payback period = 2 + (40,000 / 80,000)
= 2 + 0.5
= 2.05 years
