*The denominator of the formula becomes incremental cash flow if an old asset (e.g., machine or equipment etc.) is replaced by a new one. When net annual cash inflow is even (i.e., same cash flow every period), the payback period of the project can be computed by simply dividing the initial investment by the annual inflow of cash, as shown by the following formula: Payback period formula for even cash flow: The purchase of machine would be desirable if it promises a payback period of 5 years or less.

For example, if a company wants to recoup the cost of a machine within 5 years of purchase, the maximum desired payback period of the company would be 5 years. If the payback period of a project is shorter than or equal to the management’s maximum desired payback period, the project is accepted, otherwise rejected. You can read about that variant here.Īccording to payback method, the project that promises a quick recovery of initial investment is considered desirable. A modified variant of this method is the discounted payback method which considers the time value of money. Unlike net present value, profitability index and internal rate of return method, payback method does not take into account the time value of money. It is mostly expressed in months and years. Payback period means the period of time that a project requires to recover the money invested in it. Under payback method, an investment project is accepted or rejected on the basis of payback period.

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