Financial Modeling Tutorials
- Excel Modeling
- Financial Functions in Excel
- Sensitivity Analysis in Excel
- Sensitivity Analysis
- Capital Budgeting Techniques
- Time Value of Money
- Future Value Formula
- Present Value Factor
- Perpetuity Formula
- Present Value vs Future Value
- Annuity vs Pension
- Present Value of an Annuity
- Doubling Time Formula
- Annuity Formula
- Present Value of an Annuity Formula
- Future Value of Annuity Due Formula
- Maturity Value
- Annuity vs Perpetuity
- Annuity vs Lump Sum
- Deferred Annuity Formula
- Internal Rate of Return (IRR)
- IRR Examples (Internal Rate of Return)
- NPV vs XNPV
- NPV vs IRR
- NPV Formula
- NPV Profile
- NPV Examples
- Advantages and Disadvantages of NPV
- Mutually Exclusive Projects
- PV vs NPV
- IRR vs ROI
- Break Even Point
- Break Even Analysis
- Breakeven Analysis Examples
- Break Even Chart
- Benefit Cost Ratio
- Payback Period & Discounted Payback Period
- Payback period Formula
- Discounted Payback Period Formula
- Payback Period Advantages and Disadvantages
- Profitability Index
- Feasibility Study Examples
- Cash Burn Rate
- Interest Formula
- Simple Interest
- Simple Interest vs Compound Interest
- Simple Interest Formula
- CAGR Formula (Compounded Annual Growth Rate)
- Growth Rate Formula
- Effective Interest Rate
- Loan Amortization Schedule
- Mortgage Formula
- Loan Principal Amount
- Interest Rate Formula
- Rate of Return Formula
- Effective Annual Rate
- Effective Annual Rate Formula (EAR)
- Compounding Formula
- Compound Interest
- Compound Interest Examples
- Daily Compound Interest
- Monthly Compound Interest Formula
- Discount Rate vs Interest Rate
- Discounting Formula
- Rule of 72
- Geometric Mean Return
- Geometric Mean vs Arithmetic Mean
- Real Rate of Return Formula
- Continuous compounding Formula
- Weighted average Formula
- Average Formula
- EWMA (Exponentially Weighted Moving Average)
- Average Rate of Return Formula
- Mean Formula
- Mean Examples
- Population Mean Formula
- Weighted Mean Formula
- Harmonic Mean Formula
- Median Formula in Statistics
- Range Formula
- Outlier Formula
- Decile Formula
- Midrange Formula
- Quartile Deviation
- Expected Value Formula
- Exponential Growth Formula
- Margin of Error Formula
- Decrease Percentage Formula
- Relative Change
- Percent Error Formula
- Holding Period Return Formula
- Cost Benefit Analysis
- Cost Benefit Analysis Examples
- Cost Volume Profit Analysis
- Opportunity Cost Formula
- Opportunity Cost Examples
- APR vs APY
- Mortgage APR vs Interest Rate
- Normal Distribution Formula
- Standard Normal Distribution Formula
- Normalization Formula
- Bell Curve
- T Distribution Formula
- Regression Formula
- Regression Analysis Formula
- Multiple Regression Formula
- Correlation Coefficient Formula
- Correlation Formula
- Correlation Examples
- Coefficient of Determination
- Population Variance Formula
- Covariance Formula
- Coefficient of Variation Formula
- Sample Standard Deviation Formula
- Relative Standard Deviation Formula
- Standard Deviation Formula
- Standard Deviation Examples
- Effect Size
- Sample Size Formula
- Volatility Formula
- Binomial Distribution Formula
- Hypergeometric Distribution
- Exponential Distribution
- Central Limit Theorem
- Poisson Distribution
- Central Tendency
- Hypothesis Testing
- Gini Coefficient
- Quartile Formula
- P Value Formula
- Skewness Formula
- R Squared Formula
- Adjusted R Squared
- Regression vs ANOVA
- Z Test Formula
- Z Score Formula
- Z Test vs T Test
- F-Test Formula
- Quantitative Research
- Histogram Examples
Payback Period Formula
Payback period is one of the most popular formulas used by investors. Through payback, they want to know how long it would generally take to recoup their initial investments.
Here’s the payback period formula –
Example of Payback Formula
Let’s take an example of payback period formula.
High Rise Ltd. has been looking at different investments. They have short-listed three investments that seem to be attractive enough in terms of return. Among these three, they want to choose just one. The only criterion of this selection is the payback formula.
Here is a snapshot of three investments –
- Initial investment – $100,000; Cash inflow per year – $20,000.
- Initial investment – $150,000; Cash inflow per year – $50,000.
- Initial investment – $120,000; Cash inflow per year – $60,000.
From the point of view of payback, which project High Rise Ltd. should choose?
First, let’s calculate the payback period of the above investments.
The Payback Formula = Initial investment made / Net annual cash inflow
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- For Investment A, the payback is = $100,000 / $20,000 = 5 years.
- For Investment B, the payback is = $150,000 / $50,000 = 3 years.
- For Investment C, the payback is = $120,000 / $60,000 = 2 years.
On the basis of payback, High Rise Ltd. should choose Investment C since the payback of this particular investment is significantly lower.
Explanation of Payback Formula
Let’s take an example to illustrate the payback. Let’s say that you have enrolled for an MBA. The fees for the MBA programme are $100,000. The institute has promised that if you can complete your MBA programme successfully, you would get a job which would pay around $50,000 per annum in the beginning.
So, if you make a rough calculation of how much time it would take to get back the money you have invested in your MBA programme, then you need to calculate the payback. And here’s what you should do.
You just need to divide your initial investment by the salary you would expect to get. Actually, you should do this calculation before you ever decide to invest in an MBA programme.
And here’s the calculation for the payback (the above example) = $100,000 / $50,000 = 2 years.
Use of Payback Formula
Payback formula is widely used.
There are few reasons why this method is so very popular –
- First of all, payback Period formula is very easy to calculate. All you need to remember is the initial investment and the cash inflow in near future.
- Secondly, payback Period formula gives a tentative period of time to recoup your initial investment and as a result, you can make a prudent decision.
However, payback has few limitations as well.
- Firstly, the calculation of payback is overly simplistic. As a result, you may find it easy to calculate; but the result is not very accurate.
- Secondly, payback doesn’t take the time value of money into the account. The value of $100 today won’t be same in the next year.
- Thirdly, payback doesn’t track the ultimate profitability of the project. It concentrates too much on recouping the initial investments.
You can use the following Payback Period Calculator
|Payback Period Formula =||
Payback Period in Excel (with excel template)
Let us now do the same example as above in Excel. This is very simple. You need to provide the two inputs of Initial investment made and Net annual cash inflow.
You can easily calculate the Payback in the template provided.
This has been a guide to Payback period formula, its usefulness along with examples. Here we also provide you with payback period calculator along with Payback Period Formula excel template download. You may also have a look at these articles below to learn more about Corporate Finance.
- Payback Period Advantages and Disadvantages
- Real-Life Examples of Break-Even Analysis
- How to Create a Break-Even Chart?
- Advantages of Break-Even Analysis
- Importance of Break Even Point in Accounting
- Financial Modeling Templates
- XNPV vs NPV
- IRR vs NPV
- Break Even Point Formula
- Payback vs Discounted Payback