The length of time required to recover the original cost of an investment is known as the investment's payback period.
Added by Dawn J.
Close
Step 1
The payback period is the length of time it takes for an investment to generate enough cash flows to recover the initial cost of the investment. Show more…
Show all steps
Your feedback will help us improve your experience
Derrick Danso and 54 other Principles of Accounting educators are ready to help you.
Ask a new question
Labs
Want to see this concept in action?
Explore this concept interactively to see how it behaves as you change inputs.
Recommended Videos
10-1 - NPV A project has an initial cost of $40,000, expected net cash inflows of $9,000 per year for 7 years, and a cost of capital of 11%. What is the project's NPV? (Hint: Begin by constructing the timeline) 10-2 - IRR Refer to problem 10-1. What is the project's IRR? 10-3 - MIRR Refer to problem 10-1. What is the project's MIRR? 10-4 - Profitability Index Refer to problem 10-1. What is the project's PI? 10-5 - Payback Refer to problem 10-1. What is the project payback period? 10-6 - Discounted payback Refer to problem 10-1. What is the project discounted payback period? 10-7 - NPV Your division is considering two investment projects, each of which requires an up-front expenditure of $15 million. You estimate that the investments will produce the following net cash flows: YEAR PROJECT A PROJECT B 1 $ 5,000,000 $20,000,000 2 10,000,000 10,000,000 3 20,000,000 6,000,000 A. What are the two projects' net present values, assuming the cost of capital is: a) 5%? b) 10%? c) 15%? B. What are the two project's IRRs at the same cost of capital?
Adi S.
What information does the payback period provide? Payback period essentially provides the number of years it would take for a project to recover the initial investment from its operating cash flows. As the model was criticized, the model evolved incorporating time value of money to create the discounted payback method. The models still reflected faulty ranking criteria but they provided important information about liquidity and risk. Cash flows expected in the distant future are risky than cash flows received in the near-term—which suggests that the payback period can also serve as an indicator of project risk. Suppose ABC Telecom Inc.'s CFO is evaluating a project with the following cash inflows. She does not know the project's initial cost; however, she does know that the project's regular payback period is 2.5 years. Year Cash Flow Year 1 $300,000 Year 2 475,000 Year 3 500,000 Year 4 450,000 If the project's weighted average cost of capital (WACC) is 9%, what is its NPV? $354,910 $390,401 $372,656 $337,165 Which of the following statements indicate a disadvantage of using the discounted payback period for capital budgeting decisions? Check all that apply. The discounted payback period does not take the time value of money into account. The discounted payback period does not take the project's entire life into account. The discounted payback period is calculated using net income instead of cash flows.
A project costs $16,000. The estimated annual cash inflows during its 3-year life are $8,000, $7,000, and $6,000 respectively. What will be the payback period? a. 2 years b. 2.5 years c. 3 years d. 4 years 2. Which of the following is the sum of all present values of all cash inflows minus the present value of outflows? a. Payback period b. Internal rate of return c. Benefit-cost ratio d. Net present value 3. If you have to judge a project from its NPV, you will select the one with the a. Highest NPV b. Lowest NPV c. NPV cannot judge the project d. None of the above 4. Capital budgeting is the process of identifying, analyzing, and selecting investment projects whose returns are expected to extend beyond a. 3 years b. 2 years c. 1 year d. 6 months
Recommended Textbooks
Horngren’s Cost Accounting
Cost Accounting A Managerial Emphasis
Principles of Accounting Volume 1: Financial Accounting
Watch the video solution with this free unlock.
EMAIL
PASSWORD