Calculate Payback Period: Use the Payback Period Formula for Quick Insights

Last Updated : Sept. 12, 2023, 12:41 p.m.

A payback period calculator aids you in finding out the time taken to recover the investment you make in a project. A shorter payback tenure is preferred in contrast to longer payback tenure. Hence, calculating the period with the help of the payback period formula is necessary and useful. The tool displays the time to recover the project or an investment’s cost. The tool consists of a payback period formula box where you can input the earlier investment and quarterly cash flow. The payback tenure will display the payback tenure of an investment project. The article covers essential information about the pros and cons, benefits, how to use it, and how a payback calculator works. Read on to know more!

How to Calculate the Payback Period?

The payback period formula is as follows:

PP = I ÷ C

where,

• PP is the pay back period in years
• I refer to the overall invested sum
• C is the yearly cash inflow – the earned money

The payback period formula for calculating the payback tenure for investment when the aggregate cash flow is even is as follows:

Payback Tenure = Initial Investment / Periodic Gross Cash Flow

The payback period formula for calculating the payback tenure for an investment when the aggregate cash flow is uneven is as follows:

Payback Tenure = Years before overall retrieval + Unrecovered price at the beginning of the year / Cash flow during the year

Merits of Payback Tenure Calculation

The merits of the pay back period calculation are as follows:

• The calculation process is simple.
• It gives a glimpse of how quickly you can retrieve the initial investment.
• It gives the facility of two competing investment projects while computing the pay back period. An investment project with a short payment tenure will be better than one with a long tenure.

Demerits of Payback Tenure Calculation

The demerits of the pay back period calculation are as follows:

• The calculator needs to give details about a venture’s certain profitability. Therefore, it only displays the time utilised to retrieve the investment.
• Suppose investors are required to decide between two investment projects. In that case, deciding the payback tenure of the two investments becomes challenging because it can be a demerit in the long run.
• The pay back period isn’t realistic but a measurement.
• The payback tenure needs to concentrate on the overall investment profit.

Benefits of Payback Calculators

The following points are the benefits of using a pay back period calculator:-

• It is a simple yet effective tool helping to calculate investment returns.
• It helps in analysing investment benefits.
• It aids in identifying the involved risks in an investment.
• It helps in guiding earnings reinvestment and generating profits.

How to Use the Payback Tenure Calculator?

You can follow the ways specified below to use a payback period formula calculator:-

• Enter the investment’s initial value
• Enter the aggregate yearly cash flow.
• It shows the payback tenure in years.

How a Payback Calculator Works?

For instance, you’ve invested two lakh Indian rupees with a yearly payback of Rs. 40,000. Put the value in the following formula:-

PP = I ÷ C

PP = ₹ 2,00,000 / ₹ 40,000

PP = 5 years

Now, let’s calculate the payback tenure for irregular cash flows.

For instance, your investment in a project is four lakh Indian rupees. Rs.1,40,000 is the expected return in the first year. Rs.1,20,000 is the expected return in the second year. Rs. 1,10,000 is the return in the third year, Rs. 80,000 is in the fourth year, Rs.50,000 in the sixth year, and Rs.50,000 in the sixth year.

You can utilise the payback period formula specified below for the calculation:-

Payback Tenure = Years before overall retrieval + Unrecovered price  at the beginning of the year / Cash flow during the year

Payback Tenure =  3 + (400000 – 370000) / 80000 = 3.375

Uneven Quarterly Cash Flow Calculation

To compute the pay back period for uneven quarterly cash flows, follow the steps specified below:-

• Create a table and list the yearly cash flows.
• Compute every cash flow value. For that, you can follow the formula specified below:

PVi= Ci / (1 R)^i

where,

• PVi is the yearly cash flow’s present value.
• R is the discount rate.
• Ci is the yearly future value of cash flow.
• I refer to the year, equivalent to zero when investing, then one for a year.

• Identify the accumulated value for the cash flows. You can add the yearly cash flows with an overall cash flow sum of previous years. Therefore, the initial investment is an expenditure and will be taken as a negative value.
• Make a table with the results. At this time, the accumulated present value will change from negative to positive.
• You can utilise the following discounted payback period formula to get the accurate tenure:-

DPP = X + Y/Z

Where,

X is the year before which DPP occurs or the previous year with a negative balance.

Y is the accumulated cash flow in year ‘y’ (expressed as a positive value)

Z is the discounted cash flow in the year after the ‘y’ year.

Conclusion

Simply put, the pay back period is the expected waiting for a business’s tenure before the recovery of earlier investments in a product or project. Calculating the tenure is useful for identifying multiple investment opportunities that might be available. Here is hoping that this article has aided you in getting information related to the payback period calculator. Despite its restrictions, the payback period formula and the calculation system are an uncomplicated way to evaluate an investment project. It takes care of uncomplicated and easy needs, such as the time needed for an early investment to attain a breakthrough point, even when the investment is recovered.

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