Payback Period Calculator

How to Calculate Payback Period

The payback period is a crucial financial metric used to determine how long it takes for an investment to recover its initial cost. This guide will walk you through the process of calculating the payback period.

Payback Period Formula

The formula for calculating the payback period is:

$$\text{Payback Period} = A + \frac{B}{C}$$

Where:

• \\(A\\) is the last period with a negative cumulative cash flow
• \\(B\\) is the absolute value of the cumulative cash flow at the end of period A
• \\(C\\) is the cash flow during the period after A

Calculation Steps

1. Determine the initial investment amount.
2. List the expected cash flows for each period.
3. Calculate the cumulative cash flow for each period.
4. Identify the period where the cumulative cash flow becomes positive.
5. Apply the formula to calculate the exact payback period.

Example Calculation

Let's calculate the payback period for a project with the following details:

• Initial Investment: $10,000
• Cash Flows: $4,000 (Year 1), $3,000 (Year 2), $5,000 (Year 3)

Step 1: Calculate cumulative cash flows

Year 1: $4,000 (Cumulative: $4,000)

Year 2: $3,000 (Cumulative: $7,000)

Year 3: $5,000 (Cumulative: $12,000)

Step 2: Identify A, B, and C

A = 2 (last year with negative cumulative cash flow)

B = $10,000 - $7,000 = $3,000

C = $5,000 (cash flow in Year 3)

Step 3: Apply the formula

$$\text{Payback Period} = 2 + \frac{3000}{5000} = 2.6\text{ years}$$

Therefore, the payback period for this project is 2.6 years.

Visual Representation

This diagram illustrates the cash flows over time. The red bar represents the initial investment (negative cash flow), while the green bars represent the positive cash flows in subsequent years. The blue dashed line indicates the payback point where the cumulative cash flow equals the initial investment.