Capital Budget Payback Period Examples

The Payback Period is the time that it takes for a Capital Budgeting project to recover its initial cost. Usually management establishes a maximum payback period that a potential project must meet. Payback period can be calculated by dividing the total investment cost by the annual net cash flow. Here are two simple examples to calculate capital budget payback period.

Example 1:

Let us consider the problem: An investor makes an initial investment of 1000$ with a period of 2 years has annual cash flow of 100$ & 200$

Solution:

We can calculate the payback period using the given formula.

Formula:

Payback Period = Initial Investment / Average Annual Cash Flows

Substituting the values in the formula,

Average Annual Cash Flows= (100+200)/2 =150 Payback Period = Initial Investment / Average Annual Cash Flows 1000/150 = 6.667

Hence, Payback period is 6.667

Example 2:

Let us consider the problem: An investor makes an initial investment of 5000$ with a period of 2 years has annual cash flow of 200$ & 400$.

Solution:

We can calculate the payback using the above given formula.

Substituting the values in the formula,

Average Annual Cash Flows = (200 + 400) / 2 = 300 Payback Period = Initial Investment / Average Annual Cash Flows 5000 / 300 = 16.667

Hence, Payback period is 16.667

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