∎ PAYBACK PERIOD...
🧮 is a financial formula used to measure the time to recover initial investment
💰 helps assess risk and feasibility
💸 is calculated by adding up cash flows until investment is fully recouped
∎ IT IS KEY TO REMEMBER THAT...
👍 shorter payback periods indicate good investments
👎 longer payback periods may not be worthwhile
👨💼 this is used by investors to compare investment opportunities
💼 it’s also used by businesses to determine project viability
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📈 Payback period shows how long it takes for a business to recover an investment➠it is in fact a financial metric used to measure the length of time required for an investment to generate enough cash flows to recover its initial cost;
💰 This techinique is a way of assessing the risk associated with an investment and helps investors evaluate the feasibility of a project;
💸 The payback period is calculated by adding up the cash flows generated by the investment over time until the initial investment is fully recovered;
👍 If the payback period is shorter than the expected lifespan of the investment, then it is considered a good investment;
👎 However, if the payback period is longer than the expected lifespan of the investment, then the investment may not be satisfying and worthwhile;
👨💼 Investors can use the payback period to compare different investment opportunities and make informed decisions about where to allocate their capital;
💼 Businesses can use the payback period to determine whether a project is financially viable and whether it is worth pursuing.
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∎ FORMULA AND EXAMPLE
✎The formula is:
PAYBACK PERIOD =
Years before break-even + (Unrecovered Amount/Cash Flow in Recovery Year)
✎Let's say a company is considering investing $50,000 in a new machine that is expected to generate cash flows as follows:
Year 1: $10,000
Year 2: $20,000
Year 3: $15,000
Year 4: $8,000
Year 5: $7,000
✎To calculate the payback period, the company needs to determine how long it will take to recover the initial investment of $50,000 and different cash flows for each of the 5 following years:
Year 1: $10,000
Year 2: $30,000 ($10,000 + $20,000)
Year 3: $45,000 ($10,000 + $20,000 + $15,000)
Year 4: $53,000 ($10,000 + $20,000 + $15,000 + $8,000)
(here we have reached 50,000, then this is the recovery year and the previous one indicates years before break-even)
Year 5: $60,000 ($10,000 + $20,000 + $15,000 + $8,000 + $7,000)
✎Given the formula as above...
PAYBACK PERIOD =
Years before break-even + (Unrecovered Amount/Cash Flow in Recovery Year) =
3 + (50,000 - 45,000)/8,000 =
3.625 years =
3 years and 7.5 months
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