Bangabandhu Sheikh Mujibur Rahman Science

and Technology University, Gopalganj-8100.

Corporate Finance

December 19, 2023

Prepared by
Md. Imran Hossain | 17AIS005

2021-22, MBA, 2nd Semester

Accounting and Information systems.

-3rd member.
 Payback Period Method

A financial statistic called the Payback Period Method is used in capital planning to assess how
long it will take an investment or project to recoup its initial outlay. It is a straightforward and
popular approach, particularly for smaller projects or situations where speedy results are
important. The amount of time it takes for total cash inflows to match the initial investment is
known as the payback period.

According to Investopedia.com -

• The payback period is the length of time it takes to recover the cost of an
investment or the length of time an investor needs to reach a breakeven
point.

• Shorter paybacks mean more attractive investments, while longer

payback periods are less desirable.

• The payback period is calculated by dividing the amount of the investment

by the annual cash flow.

• Account and fund managers use the payback period to determine whether
to go through with an investment.

• One of the downsides of the payback period is that it disregards the time
value of money.

Cost of Investment
Payback Period =
𝐴verage Annual Cash Inflow

Note to Remember: The shorter the payback, the more desirable the investment. Conversely,
the longer the payback, the less desirable it becomes.
 Examples of calculating Payback Period (PBP)

A. Payback Period (PBP) of projects with even cash flows.

▪ Food Hub Co. is planning to buy a new Van at a cost of TAKA ৳10000. It will bring in

TAKA ৳1200 in net profit each year. What would the Payback Period (PBP) be?

Let’s work out the Payback Period (PBP) in years:

৳10000
Payback Period =
৳1200

= 8.333 years

B. Payback Period (PBP) of projects with uneven cash flows.

▪ Food Hub Co. is planning to buy a new Van at a cost of TAKA ৳10000.
Cashflows are given for next 4 years.

year Cashflows
0 (10000)
1 4000
2 4000
3 3500
4 2500
Total Cashflow 14000

Let’s work out the Payback Period (PBP) in years:

year Cashflows Cumulative Cashflows

0 (10000) (10000)
1 4000 4000
 2 4000 8000
3 3500 11500
4 2500 14000
Total Cashflow 14000

needed recovery amount

Payback Period =Previous yeas to Full Recovery+
𝑛𝑒𝑥𝑡 𝑦𝑒𝑎𝑟 Cash Inflow

10000−80000
= 2+
3500

= 2+ 0.571428
= 2.57 years.
 Significance in Short-Term Investment Evaluation

The significance of Payback Period Method is given below, particularly in the context of short-
term investment evaluation:

1. Quick Assessment of Liquidity: Liquidity plays a crucial role in short-term investing. The
payback period provides a rapid estimate of the time required to recover the initial expenditure.
When having quick access to money is crucial, this information is helpful.

2. Risk Mitigation: The payback time technique offers a measure of risk assessment and aids
in promptly determining when the invested cash will be returned. Shorter payback times on
investments are frequently associated with lower risk.

3. Simple Decision Making: The payback period is an easy method to calculate and understand.
This simplicity makes it a useful tool for making quick decisions.

4. Focus on Capital Recovery: This method focusses on recovery in cos of Investment.

 Limitation and Consideration

No Fact Limitation Consideration

1 Ignoring Time It does not consider the We can use discounted cash inflow.
Value of Money. time value of money.

2 Ignoring It doesn’t consider We can use Return on Investment along

Profitability profitability. with it.

3 Cash items Only focus on cash items. We should consider both cash and non-
cash items.

4 Risk Management It doesn’t analysis risk Complement the payback period analysis
associated with the with risk assessment techniques and
investment. sensitivity analysis to account for
uncertainties in future cash flows.