Payback period method is one of the traditional and simple method of evaluating the projects. In this method, the decision regarding selection or rejection of projects depend on the payback period of the proposed projects. Simply, PBP is investment recovery period. It means it is the period of recovering your investment. It is the period on which cash inflows of the project recover your initial investment. The company should select the projects having the lower payback period. While calculating PBP of the project having equal annual cash inflow, the initial investment made on that project is divided by the after tax but before depreciation cash inflows of that project. Symbolically it can be written as:
For example, suppose you invested Rs.100000 in a project
which yield you annual cash flow of Rs.25000. Here your payback period will be
4 years.
On the other hand, the PBP of the projects having uneven
cash inflows is calculated as follows:
Years
|
Cash Flow
|
Cumulative
Cash Flow
|
0
|
(100000)
|
(100000)
|
1
|
30000
|
(70000)
|
2
|
25000
|
(45000)
|
3
|
35000
|
(10000) Ã Amount to be recovered
|
4
|
20000
|
10000
|
5
|
35000
|
45000
|
