The payback Period (PBP) is a simple tool in investment analysis. it determines the amount of time takes for an investment to recoup its initial cost. It is a basic tool for investors and financial analysts to check the feasibility and profitability of an investment.
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In this article, we will provide a step-by-step guide on how to calculate Payback Period (PBP). And also give examples showing its practical use. Our goal is to provide a complete understanding of the Payback Period (PBP). To help you make informed investment decisions.
Definition
“The payback period is the amount of time it takes to recover the cost of an investment. It is defined as the number of years required to recover the original cash investment or the period of time at the end of which all costs associated with an investment are recovered. It refers to the time required to recoup funds expended in an investment, or to reach the break-even point”
What is Payback Period (PBP)?
The payback Period (PBP) is the amount of time it takes for an investment to recover its initial cost. The calculation is short and involves dividing the initial investment by the annual cash inflow generated by the investment.
For example, if you invest $100,000 in a project and expect to generate $20,000 in cash inflow each year, the Payback Period (PBP) is 5 years ($100,000/$20,000).
Why is Payback Period (PBP) important?
The payback Period (PBP) is a necessary metric in investment analysis. Because it provides a quick and simple assessment of the investment’s feasibility and profitability.
It helps investors and financial analysts to select whether an investment will recover its initial cost within a time and whether it will generate a positive return on investment (ROI).
A short Payback Period (PBP) shows that an investment will recover its initial cost faster. And maybe a better investment opportunity compared to an investment with a longer Payback Period (PBP).
How to calculate Payback Period (PBP)?
Calculating Payback Period (PBP) is short and simple. It involves the following steps:
- Choose the initial investment cost.
- Select the expected annual cash inflow from the investment.
- Divide the initial investment cost by the expected annual cash inflow.
The formula for calculating Payback Period (PBP) is:
Payback Period (PBP) = Initial Investment Cost / Annual Cash Inflow
It is important to note that Payback Period (PBP) is a simple calculation. That does not take into account the time value of money or the expected future cash flows.
Payback Period (PBP) Calculator
Examples of calculating Payback Period (PBP)
The Real-life uses of the Payback Period, let’s consider the following two examples:
Example 1: A company is considering investing $100,000 in a project that is expected to generate $20,000 in annual cash inflow for the next 5 years. Payback Period (PBP) = $100,000 / $20,000 = 5 years
Example 2: A company is considering investing $200,000 in a project that is expected to generate $40,000 in annual cash inflow for the next 5 years. Payback Period (PBP) = $200,000 / $40,000 = 5 years
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