Payback period can be defined as the time it
would require a project to recover the initial investment made in
it.
|
Calculation of Payback Period |
|
Years |
Cash flows ($) |
Cumulative Cash flows ($) |
|
0 |
(420,000) |
(420,000) |
|
1 |
180,000 |
(240,000) |
|
2 |
220,000 |
(20,000) |
|
3 |
160,000 |
140,000 |
|
4 |
(20,000) |
120,000 |
|
5 |
(80,000) |
40,000 |
|
|
|
Payback Period = 2 years + (20,000/160,000)
=2.13 years |
At year 2 the difference is ($20,000) but if we move to year 3 then
we are starting to get positive cash flows of $140,000 from the
project. Therefore the payback period has to lie between year 2 and
year 3.
Therefore Payback period will be 2.13 years in which the project
will be able to recover its initial investment.
