How the Payback Period Calculator Works
The payback period is the time an investment needs to earn back the money you put into it. A business might use it to judge a new machine, a homeowner to judge solar panels, and an investor to judge a rental. A shorter payback means your money is at risk for less time, so it is one of the quickest ways to compare projects.
What you enter
- Initial investment: what you pay at the start.
- Cash back in year 1: the profit, savings or income the investment brings in during its first year.
- Yearly change in that cash: use 0 if it stays the same each year. Use a positive number if it grows, or a negative one if it shrinks.
- Discount rate: the yearly return you could earn on your money elsewhere. It is used for the discounted payback.
- Years to look ahead: how far the calculator searches for the payback point.
Simple payback
The calculator adds up the cash you get back, year after year, until the total reaches the investment. When the cash is the same every year, the formula is short:
payback period = initial investment / yearly cash back
When the cash changes, it finds the year when the total first covers the investment. Then it works out what fraction of that year was needed, assuming the cash arrives evenly through the year:
payback = years fully passed + (investment still unpaid / cash back in the next year)
Discounted payback
Simple payback treats a dollar in year 5 the same as a dollar in year 1. But money received later is worth less, because money in hand can earn a return. Discounted payback fixes this by reducing each year's cash by the discount rate before adding it up:
value today = cash back in year t / (1 + discount rate)^t
The discounted payback is always the same as or longer than the simple payback. If it is much longer, the investment depends on far-off cash.
A worked example
You pay $50,000 for equipment that saves $12,000 a year, using a discount rate of 8%.
| Year | Cash back | Total so far | Total so far, discounted |
|---|---|---|---|
| 1 | $12,000 | $12,000 | $11,111 |
| 2 | $12,000 | $24,000 | $21,399 |
| 3 | $12,000 | $36,000 | $30,925 |
| 4 | $12,000 | $48,000 | $39,746 |
| 5 | $12,000 | $60,000 | $47,913 |
| 6 | $12,000 | $72,000 | $55,475 |
The simple payback is $50,000 / $12,000 = 4.17 years, or 4 years and 2 months. The discounted payback is later: after 5 years the discounted total is $47,913, which is still short, and it passes $50,000 during year 6, at 5.28 years, or 5 years and 3 months.
Chart: the total cash back over the years
The same example. The investment of $50,000 is earned back during year 5:
Year 1 ███████ $12,000 Year 2 █████████████ $24,000 Year 3 ████████████████████ $36,000 Year 4 ███████████████████████████ $48,000 Year 5 █████████████████████████████████ $60,000 <-- $50,000 reached Year 6 ████████████████████████████████████████ $72,000
Beyond the payback point
The calculator also shows the return and the net present value (NPV) over all the years you chose. NPV adds up the discounted cash and subtracts the investment. In the example, over 20 years the equipment brings back $240,000, a return of 380%, and the NPV is $67,818. A positive NPV means the investment beats what you could earn elsewhere at your discount rate.
Limits of the payback period
- It ignores what happens after the payback point. A project that pays back in 3 years but stops working in year 4 can look better than one that pays back in 5 years and earns for decades.
- Simple payback ignores the time value of money. Use the discounted figure for a fairer comparison.
- It says nothing about risk. The cash you expect may not arrive.
- Taxes, upkeep costs and the resale value of an asset are not included, unless you count them in the cash back.
This tool gives an estimate for general information only. It is not financial or investment advice. Real cash flows will differ from your estimates.