Payback Period Investment Appraisal Technique This is the method of investment appraisal based solely on cash flows and not profit. The payback period shows the number of years over which the investment would be recouped and measures how fast the investor can recover his/her initial investment.
It is a measure of liquidity and it ignores all other cash flows after the payback period.
The payback period pays attention to the shortness of the project, the shorter the period of
recovery of initial investment, the more acceptable the project.
For uniform cash inflows, the payback period is calculated as follows:
Payback Period = Initial Capital Investment/Annual net cash flows
The decision rule for accepting or rejecting a project is by establishing a maximum acceptable payback period.
The project is accepted if the expected payback period is less than the maximum acceptable payback period.
The project is rejected if the project period payback is greater than the acceptable payback period.
In respect of multiple projects, the project with the least payback period is accepted.