Discounted Payback Period Calculator

Discounted Payback Period Calculator

The weakness of Profitability Index is that it only compares relative returns and doesn’t consider the actual cash flow amounts. It may favor projects with higher percentages of returns, but smaller overall profits. Additionally, it assumes reinvestment at the project’s rate of return and overlooks cash flow timing. It’s best used alongside other financial evaluation methods for a comprehensive analysis. These formulas are crucial tools in financial analysis, enabling investors to determine the viability of potential projects and make informed decisions about resource allocation.

  1. To calculate payback period with irregular cash flows, you will need to calculate the present value of each cash flow.
  2. Money received in the future is worth less than money received today, due to inflation and the opportunity cost of not having that money available to invest elsewhere.
  3. WACC is the calculation of a firm’s cost of capital, where each category of capital, such as equity or bonds, is proportionately weighted.
  4. Enter the total investment amount, yearly cash flow, and average return or discounted rate into the calculator to determine the discounted payback period in years.
  5. Have you been investing and are wondering about some of the different strategies you can use to maximize your return?
  6. As a rule of thumb, the shorter the payback period, the better for an investment.

For example, an investor may determine the net present value (NPV) of investing in something by discounting the cash flows they expect to receive in the future using an appropriate discount rate. It’s similar to determining how much money the investor currently needs to invest at this same rate in order to get the same cash flows at the same time in the future. Discount rate is useful because it can take future expected payments from different periods and discount everything to a single point in time for comparison purposes.

How Is the Discounted Payback Period Calculated?

To calculate discounted payback period, you need to discount all of the cash flows back to their present value. The present value is the value of a future payment or series of payments, discounted back to the present. The payback period is favored when a company is under liquidity constraints because it can show how long it should take to recover the money laid out for the project.

Payback Period Calculation Example

Essentially, you can determine how long you’re going to need until your original investment amount is equal to other cash flows. We will also cover the formula to calculate it and some of the biggest advantages and disadvantages. The discounted payback period is often used to better account for some of the shortcomings, such as using the present value of future cash flows.

What Is a Discounted Payback Period?

NPV is the difference between the present value of cash inflows and the initial investment. By adding NPV to the initial investment and then dividing by the initial investment, the formula provides another way to assess the project’s profitability. Additionally, it’s important to consider the time value of money when interpreting payback period results.

The discounted payback period of 7.27 years is longer than the 5 years as calculated by the regular payback period because the time value of money is factored in. Explore WPS Spreadsheet, a free and powerful alternative to Microsoft Office, specifically designed to enhance financial analysis and calculations. Uncover the main features of this versatile software and understand how it facilitates effortless evaluation of the Profitability Index (PI). With WPS Spreadsheet, you can access a reliable tool for comprehensive investment analysis, making it an attractive choice for prudent investors and businesses alike. Thus, you should compare your year-end cash flow after making an investment.

Initially an investment of $100,000 can be expected to make an income of $35k per annum for 4 years. This means that you would need to earn a return of at least 9.1% on your investment to break even. This means that you would need to earn a return of at least 19.6% on your investment to break even.

It’s important to consider other metrics, such as net present value and internal rate of return, in order to get a comprehensive picture of the financial feasibility of an investment opportunity. While Excel does not have a dedicated function for calculating the payback period, you can use a combination of Excel functions and features to perform the calculation. For instance, you can use the “IF” and “VLOOKUP” functions to assist in finding the period where the cumulative cash flow becomes positive. Additionally, the “NPV” function can be used to discount the cash flows if you wish to consider the time value of money, although this is not part of the traditional payback period calculation. Other factors that may affect the accuracy of the payback period calculation include changes in interest rates, unexpected expenses, and fluctuations in the market.

This is the idea that money is worth more today than the same amount in the future because of the earning potential of the present money. Cash flow is the inflow and outflow of cash or cash-equivalents of a project, an individual, an organization, or other entities. Positive cash flow that occurs during a period, such as revenue or accounts receivable means an increase in liquid assets. On the other hand, negative cash flow such as the payment for expenses, rent, and taxes indicate a decrease in liquid assets.

Advantages and Limitations of Using Payback Period Analysis

The generic payback period, on the other
hand, does not involve discounting. Thus, the value of a cash flow equals its notional
value, regardless of whether it occurs in the 1st or in the 6th
year. However, it
tends to be imprecise in cases of long cash flow projection grant eligibility horizons or cash
flows that increase significantly over time. Therefore, it would be more practical to consider the time value of money when deciding which projects to approve (or reject) – which is where the discounted payback period variation comes in.

How to Calculate Discounted Payback Period (Step-by-Step)

In addition, the potential returns and estimated payback time of alternative projects the company could pursue instead can also be an influential determinant in the decision (i.e. opportunity costs). The breakeven point is the price or value that an investment or project must rise to cover the initial costs or outlay. Unlike other methods of capital budgeting, the payback period ignores the time value of money (TVM).

Amanda Bellucco-Chatham is an editor, writer, and fact-checker with years of experience researching personal finance topics. Specialties include general financial planning, career development, lending, retirement, tax preparation, and credit. You can think of it as the amount of money you would need today to have the same purchasing power as a future payment. Have you been investing and are wondering about some of the different strategies you can use to maximize your return?

Once we’ve calculated the discounted cash flows for each period of the project, we can subtract them from the initial cost figure until we arrive at zero. Next, assuming the project starts with a large cash outflow, or investment to begin the project, the future discounted cash inflows are netted against the initial investment outflow. The discounted payback period process is applied to each additional period’s cash inflow to find the point at which the inflows equal the outflows. At this point, the project’s initial cost has been paid off, with the payback period being reduced to zero. The shorter a discounted payback period is means the sooner a project or investment will generate cash flows to cover the initial cost.

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