Payback Period Method
Payback is the number of years required to recover the original cash flow outlay investment in a project.
The payback is one of the most popular and widely recognized traditional methods of evaluating investment proposals.
If the project generates consistent annual cash inflows, the payback period can be computed by dividing cash outlay by the annual cash inflow. That is:
Payback = Initial investment / Annual Cash inflow
Acceptance Rule
Many firms use the payback period as an investment evaluation criterion and method of ranking projects. They compare the project’s payback with a predetermined, standard payback. The project would be accepted if its payback period is less than the maximum or standard payback period set by management. As a ranking method, it gives highest ranking to the project, which has the shortest payback period and lowest ranking to the project with highest payback period. Thus, if the firm has to choose between two mutually exclusive projects, the project with shorter payback period will be selected.
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