Calculating payback analysis.
Payback analysis looks at the amount of time a company needs to recoup the costs of a project. Projects can vary, from creating a new division to the purchase of new equipment. At times, companies will need to choose between more than one investment. One ratio the managers must look at is how long the project will take to recoup its value. One downside to payback analysis is it does not take into account the time value of money.
Instructions
1. Determine the cost of the investment. This is the total cash outflows the capital investment will have before it becomes operational. For example, a firm buys a truck for $40,000.
2. Calculate the average annual cash inflows from the investment. In our example, the firm estimates the truck will increase revenues by $7,000 a year.
3. Divide the cost of the investment by the average annual cash inflows from the investment. In our example, $40,000 divided by $7,000 equals 5.72 years until the project pays back its original cost.
