# Payback Period Calculator

This payback period calculator will show you how many years it will take to recover your initial investment in a project. The payback period can be calculated for a project with fixed cash flows or irregular cash flows.

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How often do you expect to receive this cash flow?
What's the payback period?
Payback period
58.8
months
On an initial investment of $5,000 that generates$85 every month, the payback period is 58.8 months or 4.9 years.
Payback period
58.8
Months
19.6
Quarters
9.8
Half years
4.9
Years

## What is the payback period?

The payback period for a project is the amount of time required to recover the project’s initial investment. It answers the question: How soon will I recover my initial investment?

The payback period formula, assuming projects has the same cash flows every year, is:

The payback period formula assumes that there is:

1. Initial investment: An initial outflow of cash investment at the beginning of the project
2. Future cash flows: A series of cash flows generated in the future by the project

It then asks the question, after how many years will my investment breakeven?

Let's look at an example.

### Example

I invested $1 million into a sandwich shop. Every year, the sandwich shop will generate$250,000. What is the payback period?

Let's use the payback period formula:
Payback period = Initial investment / Annual cash flow
Payback period = $1,000,000 /$250,000 per year
Payback period = 4 years

You will recover your initial investment of $1 million in 4 years. The cash flows from the project are in the table and graph below. The net invested cash is the cumulative cash flow less the initial investment. Net invested cash = Cumulative cash flow - initial investment We have reached the payback period or breakeven point when this is$0.

Year Cash flow Net invested cash

## Why is the payback period rule used?

Given the disadvantages of the payback period method, why and how is it used?

The payback period method is very easy to calculate and can be an easy shortcut when evaluating a lot of projects. It can be used as a ‘reality check’ before deciding to spend more time on analyzing the project and calculating other ROI metrics.

The method can help answer the question, “Should we investigate further into this project?”

### Using the payback period method to evaluate small projects

The payback period method is more often used for small-dollar decisions. As a result, it is used by small firms more often than large firms and by large firms only for small projects. For example, a company might have a rule that requires all projects with an initial investment of \$20,000 or less to have a payback period of 2 years or less.

### Future cash flows are hard to estimate

While one of the shortcomings of the payback method is that it ignores cash flows that are way into the future, the counter argument is that future cash flows on small projects may be too hard to estimate anyway. They can also be time consuming to estimate.

Short-term cash flows can be estimates more accurately and more easily.

Focusing on the short-term also removes some of the risk of the long-term. For example, the economic climate could change, new competitors could enter the industry, and technology could change.

### Initial screen

The payback period method is a good first screen.

### Time value of money

However, the payback method still ignores the time value of money. We can take this into account by adding discounting to our future cash flows.

## Discounted payback period

The discounted payback period method fixes the problem of ignoring the time value of money.

Future cash flows are adjusted and restated in current dollars by using a discount rate.

## Alternatives to the payback period rule

While the discounted payback period adjusts for the time value of money, it is still flawed.

It ignores future cash flows after the initial investment has been recovered. But this future cash flow is very important to determining whether a project should be funded.

To take this into account, we should use a discounted cash flow model that includes all future cash flow - this is the net present value method.