payback period method

payback period method
A method of capital budgeting in which the time required before the projected cash inflows for a project equal the investment expenditure is calculated; this time is compared to a required payback period to determine whether or not the project should be considered for approval. If the projected cash inflows are constant annual sums, after an initial capital investment the following formula may be used:
payback (years) = initial capital investment/annual cash inflow.
Otherwise, the annual cash inflows are accumulated and the year determined when the cumulative inflows equal the investment expenditure. The method is sometimes seen as a measure of the risk involved in the project.
The two major weaknesses of the payback method are:
• the time value of money is not considered;
• the cash flows after the investment is recovered are not considered.
However, payback is a relatively simple technique for managers to use and for this reason it remains popular. Often managers use payback and discounted cash flow techniques at the same time, even though they are very different methods of capital budgeting (see discounted payback method).
example
A hospital is considering the purchase of a new X-ray machine for £50,000. The annual cash savings from the new machine are estimated at £20,000.
payback = initial capital investment/annual cash inflows = £50,000/£20,000 = 2.5
The hospital will therefore recover its investment in 2.5 years. On this basis, it is difficult to say whether the hospital should buy the new machine. Most managers would see a payback period of less than 3 years as good.

Accounting dictionary. 2014.

Игры ⚽ Нужен реферат?

Look at other dictionaries:

  • payback period method — A method of capital budgeting in which the time required before the projected cash inflows for a project equal the investment expenditure is calculated; this time is compared to a required payback period to determine whether or not the project… …   Big dictionary of business and management

  • Payback 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, as longer payback periods are typically not… …   Investment dictionary

  • Payback period — in business and economics refers to the period of time required for the return on an investment to repay the sum of the original investment. For example, a $1000 investment which returned $500 per year would have a two year payback period. It… …   Wikipedia

  • discounted payback method — A method of capital budgeting in which managers calculate the time required before the forecast discounted cash inflows from an investment will equal the initial investment expenditure (see discounted cash flow). This method is similar to the… …   Accounting dictionary

  • discounted payback method — A method of capital budgeting in which managers calculate the time required before the forecast discounted cash inflows from an investment will equal the initial investment expenditure (see discounted cash flow). This method is similar to the… …   Big dictionary of business and management

  • Operation Payback — is a coordinated,[1] decentralized[2] group of attacks on opponents of Internet piracy by Internet activists using the Anonymous moniker a group sometimes affiliated with the website 4chan. Operation Payback started as retaliation to distributed… …   Wikipedia

  • capital budgeting — capital investment appraisal; = investment appraisal The process by which an organization appraises a range of different investment projects with a view to determining which is likely to give the highest financial return. The approaches adopted… …   Accounting dictionary

  • decision model — A model that simulates the elements or variables inherent in a business decision, together with their relationships to each other and the constraints under which they operate; the purpose of the model is to enable a solution to be arrived at in… …   Accounting dictionary

  • financial appraisal — The use of financial evaluation techniques to determine which of a range of possible alternatives is preferred. Financial appraisal usually refers to the use of discounted cash flow techniques but it may also be applied to any other approaches… …   Accounting dictionary

  • capital budgeting — The process by which an organization appraises a range of different investment projects with a view to determining which is likely to give the highest financial return. The approaches adopted include net present value, the internal rate of return …   Big dictionary of business and management

Share the article and excerpts

Direct link
… Do a right-click on the link above
and select “Copy Link”