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How Does The Payback Period Calculator Work?
The Payback Period Calculator is a tool created to assist you in determining the payback period. The payback period is effectively the period needed for an investment based on cash flow to reach the point at which positive cash flows and negative cashflows equal zero, commonly known as the break-even point. It is often used to express ROI (Return on Investment) as it is relatively simple to calculate. But it does not factor in the time value of money, a theory that states that cash received today is more valuable than what you may receive tomorrow.
Within the calculator, you can enter the initial investment amount, the cash flow, the discount rate, and the number of years. Entering the necessary values and pressing calculate returns a list of results that consists of details such as the payback period, the cash flow return rate as well as the discounted payback period should you choose to mention the discount rate as well.
How To Calculate Payback Period?
Calculating the payback period in this calculator is a fairly straightforward process. Enter the initial investment amount and the cash flow into the calculator and press calculate. Cash flow is the inflow and outflow of currency. An increase in cash indicates an increase in assets, while a negative value denotes incurred expenses. Once we enter the values, the website does the rest, presenting you with the payback period.
For example, if Nathan wishes to invest $1000 with an annual payback of $200, all he has to do is enter the values into the calculator. It returns the payback period, five years. But this method does not consider the time value of money. Consider using the calculator to calculate the discounted payback period if you want to take it into account.
How To Calculate Discounted Payback Period?
The discounted payback period is the period necessary to reach the break-even point, as mentioned earlier, based on the net present value of the cash flow. This calculation accounts for the time value of money. If the discounted payback period is lower than a predetermined time, you can treat the investment as viable. Else, one need not consider the said investment. Investments with shorter discounted payback periods are preferred. This preference is because they take less time than other investments to break-even.
For example, let us assume Nathan invests $100 with an annual payback of $20 and a discount rate of 10%. He inputs these values into the calculator and finds out that the break-even point is 7.27 years. This period is longer than five years; the value that would have been returned had he chosen to use the standard method of determining the payback period. This difference is because of the consideration of the time value of money. Often, the discounted payback period will be larger than the regular payback period.
Both discounted payback period and payback period are important metrics that help distinguish between opportune investments and ones that aren’t worth the risk. You can use them in tandem with parameters like the internal rate of return to make good on your returns.