How To Calculate Payback Period
Learn how to calculate the payback period for your investment with an experienced financial analyst. A simple example is used to get you started.
Hi, my name is Grant Hobson, I've been a finance analyst for the last six years. Today, I'm going to run you through some financial performance methods as well as some investment appraisal techniques. In terms calculating the payback, if we look at the example, we have an initial cash outflow of two hundered and fifty pounds.
In year one, we expect this to generate sixty pounds, in year two, seventy five pounds, year three, one hundered pounds and in years four and five, hundred fifty five pounds, a hundred and fifty pounds a year. Now in order to calculate the payback, we need to look at these totals cumulatively across the time period. So we have the period, the value from period two, to total in period one, gives a cumulative of 135 pounds by the close of year two.
You copy this down, and I reach year to the previous cumulative total, by the end of year five, we see that this investment has generated five hundered and thirty pounds for us. Now in terms of the payback, we are only interested in when this two hundered and fifty pound investment comes back to us. So by year one, we have only generated sixty pounds, that far we have not reached to two fifty, then cumulative for year two, one three five, again not to two fifty, and the same for year three, we are still fifteen pounds short.
However, by the close of year four, we have generated 385 pounds, so the payback period falls between years three and years four. In order to calculate how far into year four, the payback period is, we simply take the difference from year three to close of year four, one hundred and fifty pounds, and as we need fifteen pounds, you then divide by the hundered and fifty which is point one. We have seen that through the year we generate this hundered and fifty pound evenly.
So total payback period is your three years plus the point one of year four. So the payback period is three point one years on this investment. .