Payback Period

# Payback Period

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## Payback Period

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1. Payback period refers to the time it takes(i.e. n) to recover the initial investment cost (i.e. P) of an investment. General equation is: 0 = -P  A(P/A,i,n)  F(P/F,i,n) ( frequently requires trial and error solution) Business persons sometimes use simple payback (ignoring interest). Such a procedure,while ‘simple’, obviously yields a lower n value than the correct one. Payback Period

2. Example: A racing team purchased a transporter for \$175,000.They will be able to sell the truck at any time within the next 5 years for \$90,000, after which it will sell for \$70,000. If they expect to win an average of \$25,000 more per year because of the truck (i.e. being able to go to more races), how long will it take to recover their investment at (a) i = 0%,and (b) i = 12% per year? (b) 0 =- 175,000 +25,000(P/A,12%,n) + 90,000(P/F,12%,n) for n≤5 0 =- 175,000 +25,000(P/A,12%,n) + 70,000(P/F,12%,n) for n>5 Payback Period Example Solution: (a) 0 = -175,000 + 25,000(n) + 90,000 n = 3.4 ,or 4 years By trial and error, n =12.6 , or 13 years