Pay Back Period Details Information

Q. Define Pay Back Period:

The length of time required to recover the cost of an investment. The payback period of a given investment or project is an important determinant of whether to undertake the position or project.

Payback period is calculated as:

PBP = A+(NCO-C)/A

Here, A=The year at which the cumulative cash flow to net cash flow

NCO= Nest cash flow

C= Cumulative cash flow at the year A.

Q. How Payback period is used in capital budgeting decision:

Payback period is used in capital budgeting decision are as payback period in capital budgeting refers to the period of time required for the return on an investment to ‘repay’ the sum of the original investment. This time value of money is not taken into account. Payback period intuitively measures how long something takes to ‘Pay for itself’. The term is also widely used in other types of investment areas, often with respect to energy efficiency technologies, maintenance, upgrades, or other changes.

Q. What are the major constraints of this method (Payback period):

There are some major constraints/ problems with the payback period method:

1. Payback period ignores any benefits that occur after the payback period and therefore, does not measure profitability.

2. It ignores the time value of money.

3. Additional complexity arises when the cash flow changes sign several times, i.e., it contains outflows in the midst or at the end of the project lifetime.