Monday, April 13, 2009

Calculation of Payback Period

The payback period of a machine purchase is calculated by estimating the number of years it will take to recover the cash invested in a capital budgeting project. 

The payback period can be calculated in the following manner. 

When the cash inflows are even and predictable it is easier to calculate the payback period. For example, if the annual cash inflow is standard or the cash flow is in the form of an annuity, the computation of the payback period is simple. 

Payback Period Equation: Initial Investment/ Annual Cash Inflow

Example of Payback Period Calculation:

If $20,000 is invested in a manufacturing machine, and the machine is invested to produce an annual cash inflow of $5,000 for 7 years, then

Payback Period = $20,000/$5,000 = 4

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