Payback Period
Payback Period
Time required to recover the initial investment from cumulative undiscounted cash flows. Linearly interpolates within the period when cumulative cash flow first turns non-negative.
When to use: A simple liquidity-focused screen: how fast does the project return the money? Useful as a sanity check alongside NPV/IRR, especially for short-horizon decisions or when capital is illiquid. Ignores time value of money — pair with discounted payback or NPV for a complete picture.
Formula
Variables
| Symbol | Name | Description | Unit |
|---|---|---|---|
| Payback | Payback Period | Time required to recover the initial investment from cumulative cash flows | years |
| CashFlows | Cash Flows | Sequence of cash flows starting at period 0 (negative for outflows, positive for inflows) | $ |
Real-Life Examples
Example 1: 4-Year Project
Invest $1,000 today, receive $400/year for 4 years. When does it pay back?
Given
Step-by-Step
Payback period is 2.5 years — half of the 4-year life. Common rules of thumb: payback < half the project life is favorable.
Example 2: Uneven Cash Flows
Invest $10,000, receive $3,000, $4,000, $5,000, $2,000.
Given
Step-by-Step
Pays back in 2.6 years. Early-loaded cash flows shorten payback even when total CF is similar.
Frequently Asked Questions
Linear interpolation assumes cash accrues evenly during the recovery year. If payments arrive only at year-end, use the next whole year instead.
Not necessarily. Later outflows can reverse recovery, and payback ignores cash flows after the first crossing. It also ignores the time value of money.