If you made an investment and want to know how long it will take before you could break even, then the payback period calculator is just what you need. Payback period calculator is a simple tool that allows you to estimate how many years need to pass before you can recover your initial investment. You may even use this tool to analyze different possibilities on where to make your investment or combine it with the other online tools.
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How to use the payback period calculator?
Rather than using a payback period formula, this online calculator can do the work for you. This project payback calculator is a simple tool that will provide you with quick and accurate results. To use it, follow these steps:
- First, enter the Discount Rate which is a percentage value.
- Then enter the Initial Investment and the Annual Cash flow which are monetary values.
- Entering the required values will prompt the discounted payback period calculator to provide you with the Payback Period and the Discounted Payback Period.
How do you calculate payback period?
Let’s say that you wanted to invest your money by buying an apartment. Your initial investment is $100,000 then you will rent the property out for $24,000 annually. How many years will you need so that the apartment can pay back its initial investment? Use this payback period calculator or calculate manually by using this payback period formula:
PP = I / C
where:
PP refers to the payback period
I refers to the total amount invested.
C refers to the annual cash flow
Therefore:
PP = $100,000 / $24,000 per year = 4.17 years.
What is simple payback period?
A simple payback period is the required amount of time to get back how much you’ve spent on an investment. This payback period is essential when making an investment as it could help you decide if you should proceed with your intended project or investment. Typically, long payback periods aren’t ideal for investment positions. Furthermore, a payback period is just a measure of time and doesn’t care about the Time Value of Money or TVM.
Almost all aspects of corporate finance are part of capital budgeting. A corporate financial analyst’s job is to learn how to assess various operational projects or investments. It’s his job to look for investment projects that would make for the corporation the most profits. One method corporate analyst’s can implement this is by using the payback period.
A lot of formulas involved in capital budgeting consider TVM. This concept involved here is that money in the present should have a higher worth than the same monetary amount after time has passed is due to the present money’s potential to earn. For instance, if you’re paying an investor in the future, it should include the opportunity cost. The TVM will assign the value to an opportunity cost.
However, payback periods don’t take into consideration the TVM. It’s simply a measure on the length of time it would take to get back the invested funds. A simple illustration can explain this. If it takes three years to recover the cost of investment, then the payback period is three years. Because of the formula’s simplicity, many analysts prefer using the method. Others though, use this as an added reference point in a framework which includes capital budgeting decisions.
What is the discounted payback period?
There are situations when you may take into consideration the TVM in the payback period equation. Logically, the $100,000 investment you might not have the same worth after ten years. As a matter of fact, it could be worth much less. Each year, you will see your investment decrease in value by a specific percentage, and this is what we refer to as the discounted rate.
Different from the simple payback period, the discounted payback period will take into account your investment’s decrease in value. If you use the discounted payback period calculator, you will get a value that’s more realistic although without a doubt, will have a lower value.
Let’s look at the formula. First, let’s assume that you have a constant cash inflow, meaning you earn the same amount every year. Let’s also set the discount rate at 5% to make computations much easier:
DPP = – ln (1 – I * R / C) / ln (1 + R)
where:
DPP refers to the discounted payback period
R refers to the discount rate
I refers to the total amount invested
C refers to the annual cash flow
Therefore:
DPP = -ln (1-$100,000 * 0.05 / $24,000) / ln (1 + 0.05) = 4.79 years
Compare the two results where the PP = 4.17 years and the DPP = 4.79 years. Taking depreciation into consideration, there will be a longer time required for the recovery of investment by 0.62 years.
What is an acceptable payback period?
People who invest, especially the first-timers will usually ask, “When will I get my money back?.” The answer to this question is the payback period and to get this, you will need the initial investment and the cash flow.
New investors need to know that the payback period has nothing to do with investment evaluations as it does not take into account the TVM. You can switch the cash flows for the first year with that of the third and the payback period won’t change, even though you received more money in the first year. There are, indeed, drawbacks when using the payback period formula but it scores high because of its simplicity.
What then is an acceptable payback period for investments in small or medium scale business? There is no telling. To have an answer, you will first need the data required for calculations. What we know is that there are common multiples for transactions for small and medium-sized businesses.
Small ones usually sell between 2 – 3 times the Seller’s Discretionary Earnings or SDE while medium ones sell between 4 – 6 times the Earnings Before Interest, Taxes, Depreciation, and Amortization or EBITDA. Of course, this doesn’t mean that for these businesses, the payback period will only be 2 -3 and 4 – 6 years respectively.
