Guide to Financial Management by The Economist

Author:The Economist
Language: eng
Format: epub
Publisher: PublicAffairs
Published: 2018-08-20T16:00:00+00:00

Payback

This is the simplest method of investment appraisal and provides a quantification of risk in terms of measuring how quickly the original investment is returned. The general principle is that projects which recoup their initial cash investment faster are more attractive. Risk here is defined as uncertainty, because predicting cash flows next year is likely to be more accurate than predicting those in five years’ time. The measure is the time taken to reach the cash break-even point, when the total cash out equals the total cash in.

On the cumulative cash flow curve shown in Figure 11.4, the payback is the time it takes for the line to return back to zero. The effect on the two projects is shown in Table 11.9.

The payback for project A is four years and for project B it is two years and four months (if cash is earned evenly through each year).

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