Payback Period

The period of time required to recover the net investment is called payback period, P_B.
The project which pays back the initial investment in the smallest period is acceptable under this method.
Decision:
If (calculated P_B < standard  P_B) => Accept the project
If (calculated P_B > standard  P_B) => Reject the project
Merits of payback period:
ü  Easy to understand and inexpensive to use.
ü  Easy and crude way to analyze the risk.
ü  Uses all cash flow information.
ü  Considers liquidity.
 
Demerits:
û  Ignores the time value of money.
û  Ignores cash flow occurring after payback period.
û  Not objective way to determine the standard payback period.
û  Not a measure of profitability.
û  Payback period ignores the wealth maximization.
 
Types of Payback period:

1. 1. Simple payback period
2. 2. Discounted payback period