Calculate the simple and discounted payback period — how long until your initial investment is recovered from cash inflows.
| Year | Cash inflow | Cumulative | Discounted cum. |
|---|
The payback period is the time required for an investment to generate cash flows equal to the initial cost — the "break-even" point in time. It is one of the simplest and most intuitive capital budgeting tools, answering: "How long before I get my money back?" A shorter payback period indicates faster cost recovery and lower capital-at-risk duration.
| Feature | Simple Payback | Discounted Payback |
|---|---|---|
| Accounts for time value of money | No | Yes |
| Complexity | Very simple | Moderate |
| Result | Shorter period (optimistic) | Longer period (realistic) |
| Best for | Quick screening of projects | More accurate investment analysis |
| Year | Annual Cash Flow | Cumulative Simple | Cumulative Discounted (8%) |
|---|---|---|---|
| Initial cost | −$100,000 | −$100,000 | −$100,000 |
| Year 1 | $30,000 | −$70,000 | −$72,222 |
| Year 2 | $30,000 | −$40,000 | −$46,502 |
| Year 3 | $30,000 | −$10,000 | −$22,614 |
| Year 4 | $28,000 | +$18,000 ✅ | −$2,054 |
| Year 5 | $28,000 | +$46,000 | +$17,000 ✅ |
Simple payback: approximately 3.36 years. Discounted payback (at 8%): approximately 4.07 years. The discounted payback more accurately reflects the true cost recovery because it accounts for the fact that future dollars are worth less than current dollars.
What is a good payback period for an investment?
It depends entirely on the investment type and industry. For business equipment: typically 2-4 years is considered acceptable. For residential solar panels in Australia: 4-7 years is typical. For major capital projects: 5-10 years may be acceptable if returns continue well beyond payback. Higher-risk projects require shorter payback periods to compensate for uncertainty.
What is the difference between simple and discounted payback period?
Simple payback divides the investment cost by average annual cash flows — quick but ignores the time value of money. Discounted payback converts all future cash flows to today's dollars before accumulating them, giving a more realistic recovery period. The discounted payback period is always longer than the simple payback period for the same investment.
What are the limitations of payback period analysis?
The main limitations: it ignores all cash flows after the payback point (a project with 3-year payback and 5 total years may be worse than one with 4-year payback and 25 total years); simple payback ignores the time value of money; and it doesn't measure profitability or total return. Use payback as a screening tool alongside NPV and IRR, not as a standalone decision metric.