Question

Consider an investment that costs $400 and pays $100 per year forever. What is the payback period? What is the discounted payback?

Answer 1

Project’s Payback Period

- The Payback Period Method refers to the period in which the proposed project will generate the cash inflows to recover the Initial Investment costs. It considers only three components such as Initial Investment costs, Economic life of the project and the annual cash inflows

- Payback period is the number of years taken to recover the total amount of money invested in the project. If the payback period is less than the enterprises required number of years, then the project should be accepted, Else it is rejected.

-The Payback Period = Initial Investment / Annual cash inflow

The Payback Period for the Project is calculated by using the following formula

Project’s Payback Period = Initial Investment Cost / Annual Cash Inflow

= $400 / $100 per year

= 4 Years

To Calculate the Discounted Payback Period, we, need Discount Rate or the Cost of Capital to discount the annual cash inflows.