Payback Period Definition
source: Lifehacker.com.au The above article notes that Tesla’s Powerwall is not economically viable for most people. As per the assumptions used in this article, Powerwall’s payback ranged from 17 years to 26 years. Considering Tesla’s warranty is only limited to 10 years, the payback period higher than 10 years is not ideal. Payback Period FormulaThe payback period formula is one of the most popular formulas used by investors to know how long it would generally take to recoup their investments and is calculated as the ratio of the total initial investment made to the net cash inflows. You are free to use this image on your website, templates, etc, Please provide us with an attribution linkArticle Link to be Hyperlinked Steps to Calculate Payback Period
Calculation with Uniform cash flowsWhen cash flows are uniform over the useful life of the asset, then the calculation is made through the following formula. Payback period Formula = Total initial capital investment /Expected annual after-tax cash inflow. Let us see an example of how to calculate the payback period when cash flows are uniform over using the full life of the asset. Example:A project costs $2Mn and yields a profit of $30,000 after depreciation of 10% (straight line) but before tax of 30%. Lets us calculate the payback period of the project. Profit before tax $ 30,000 Less: [email protected]%(30000*30%) $ 9,000 Profit after tax $ 21,000 Add: Depreciation(2Mn*10%) $ 2,00,000 Total cash inflow $ 2,21000 While calculating cash inflow, generally, depreciation is added back as it does not result in cash out flow. Payback Period Formula = Total initial capital investment /Expected annual after-tax cash inflow = $ 20,00,000/$2,21000 = 9 Years(Approx) Calculation with Nonuniform cash flowsWhen cash flows are NOT uniform over the use full life of the asset, then the cumulative cash flow from operationsCash flow from Operations is the first of the three parts of the cash flow statement that shows the cash inflows and outflows from core operating business in an accounting year. Operating Activities includes cash received from Sales, cash expenses paid for direct costs as well as payment is done for funding working capital.read more must be calculated for each year. In this case, the payback period shall be the corresponding period when cumulative cash flows are equal to the initial cash outlay. In case the sum does not match, then the period in which it lies should be identified. After that, we need to calculate the fraction of the year that is needed to complete the payback. Example:Suppose ABC ltd is analyzing a project which requires an investment of $2,00,000 and it is expected to generate cash flowsCash Flow is the amount of cash or cash equivalent generated & consumed by a Company over a given period. It proves to be a prerequisite for analyzing the business’s strength, profitability, & scope for betterment. read more as follows
In this cash payback period can be calculated as follows by calculating cumulative cashflows
Suppose, in the above case, if the cash outlay is $2,05,000, then pa back period is
For up to three years, a sum of $2,00,000 is recovered, the balance amount of $ 5,000($2,05,000-$2,00,000) is recovered in a fraction of the year, which is as follows. Forgetting $20,000 additional cash flows, the project is taking complete 12 months. So for getting additional of $ 5,000($2,05,000-$2,00,000) it will take (5,000/20,000) 1/4th Year. i.e., 3 months. So, the project payback period is 3 years 3 months. Advantages
DisadvantagesThe following are the disadvantages of the payback periodPayback period is a very simple method for calculating the required period; it does not involve much complexity and aids in analyzing the project's reliability. Its disadvantages include the fact that it completely ignores the time value of money, fails to depict a detailed picture, and ignores other factors as well.read more.
Payback ReciprocalPayback reciprocal is the reverse of the payback period, and it is calculated by using the following formula Payback reciprocal = Annual average cash flow/Initial investment For example, a project cost is $ 20,000, and annual cash flowsCash Flow is the amount of cash or cash equivalent generated & consumed by a Company over a given period. It proves to be a prerequisite for analyzing the business’s strength, profitability, & scope for betterment. read more are uniform at $4,000 per annum, and the life of the asset acquire is 5 years, then the payback period reciprocal will be as follows. $ 4,000/20,000 = 20% This 20% represents the rate of return the project or investment gives every year. Payback Period VideoRecommended Articles
What is the formula for the payback method when you have even cash flows?If the cash flows are even you have the formula: Payback Period = Initial Investment / Net Cash Flow per period If the cash flows are uneven you have: Payback Period = Years before full recovery + Unrecovered cost at the start of the year / Cash flow during the year The ClearTax Payback Period Calculator calculates the ...
What formula do you use to calculate the payback period?The payback period is calculated by dividing the amount of the investment by the annual cash flow.
What is payback period with example?The Payback Period method does not take into account the time value of money and treats all flows at par. For example, Rs. 1,00,000 invested yearly to make an investment of Rs. 10,00,000 over a period of 10 years may seem profitable today but the same 1,00,000 will not hold the same value ten years later.
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