Payback Period Calculator
Payback period is how long an investment takes to recover its cost. It is conceptually simple, easy to communicate, and ignores everything that happens after recovery.
The payback formula
For uniform cash flows: Payback = Initial investment / Annual cash flow. For variable cash flows, sum cash flows year by year until cumulative cash equals or exceeds the initial investment, interpolating within the year of recovery for a fractional answer.
Discounted payback
Simple payback ignores the time value of money — a dollar in year five is treated as worth a dollar in year one. Discounted payback applies a discount rate to each cash flow before summing, recovering only when discounted cumulative cash equals the initial investment. Discounted payback is always longer than simple payback (assuming positive discount rate and non-negative flows).
Worked example
A piece of equipment costs $100,000 and produces $25,000, $30,000, $35,000, and $40,000 over four years. Cumulative cash after year three: $90,000 (still short). After year four: $130,000. Simple payback falls within year four: 3 + (10,000 / 40,000) = 3.25 years. At a 10% discount rate, cumulative discounted cash after year four is roughly $99,000 — still slightly short — so discounted payback exceeds four years.
Why payback isn't enough on its own
- Ignores cash flow after recovery. A project paying back in two years and then ending is identical to one paying back in two years and then earning for ten more, by this metric. Use NPV or IRR alongside payback for any non-trivial decision.
- Ignores magnitude. Paying back $10,000 in two years and paying back $10,000,000 in two years are not the same opportunity, but payback period treats them as equivalent.
- Encourages short-term thinking. Used as a stand-alone hurdle ("we only invest in projects with payback under three years"), it systematically biases against long-duration investments — including most R&D and infrastructure.
When payback is the right metric
Three legitimate uses: liquidity-constrained businesses where time-to-cash recovery matters more than total return; high-uncertainty projects in volatile markets where forecasts beyond the payback period are unreliable; and quick-screen filters before more rigorous NPV/IRR analysis on the survivors.