Siddhartha

Payback period
Payback period is the time in which the initial cash outflow of an investment is expected to be recovered from the cash inflows generated by the investment. It is one of the simplest investment appraisal techniques. Payback period as a tool of analysis is often used because it is easy to apply and easy to understand for most individuals, regardless of academic training or field of endeavor. When used carefully or to compare similar investments, it can be quite useful. As a stand-alone tool to compare an investment to "doing nothing," payback period has no explicit criteria for decision-making.
The payback method should not be used as the sole criterion for approval of a capital investment. Instead, consider using the net present value and internal rate of return methods to incorporate the time value of money and more complex cash flows, and use throughput to see if the investment will actually boost overall corporate profitability. There are also other considerations in a capital investment decision, such as whether the same asset model should be purchased in volume to reduce maintenance costs, and whether lower-cost and lower-capacity units would make more sense than an expensive "monument" asset.

Calculation of Payback period
Using 15% discount factor
For project A
(In thousand US dollar)
Year | Cash flow | Discount factor (15%) | Discounted Cash flow | Cumulative Discounted cash flow |
1 | 300 | 0.8696 | 260.88 | 260.88 |
2 | 350 | 0.7561 | 264.64 | 525.52 |
3 | 500 | 0.6575 | 328.75 | 764.27 |
4 | 600 | 0.5718 | 343.08 | 1107.35 |

| Amount to recover |
| Cash flow during the year |

Payback period = Minimum year +
| (1000 – 764.27) |
| 343.08 |

= 3 years +

= 3.687 years

Project B
(In thousand US dollar)
Year | Cash flow | Discount factor (15%) | Discounted Cash flow | Cumulative Discounted cash flow |
1 | 800 | 0.8696 | 695.68 | 695.68 |
2 | 400 | 0.7561 | 302.44 | 998.12 |
3 | 200 | 0.6575 | 131.50 |...