How to use the payback period calculator
- Enter the initial investment, the cash paid out at the start.
- Enter the discount rate, your required return or cost of capital. It is used for the discounted payback and the NPV only.
- Choose how to enter the cash flows. Pick Different each year to type each year’s net cash flow, or The same every year to enter one amount and the number of years.
- Add a maximum acceptable payback if your company or your own rule sets one. The calculator then shows whether the project passes on each measure.
The chart plots the cumulative cash position, undiscounted and discounted. Each payback period is where its line crosses zero.
How payback is calculated
Even cash flows: Payback = I ÷ AY is the last full year in which the cumulative cash flow is still negative, I the initial investment and A the equal annual cash flow. The fraction assumes cash arrives evenly through year Y + 1.
If the cumulative total never reaches zero within the years entered, the project never pays back and the calculator shows how far short it falls.
A worked example
A $50,000 project returns $12,000, $15,000, $18,000, $16,000, $14,000 and $10,000 over six years. After three years, $45,000 has come back and $5,000 is still to recover. Year 4 brings $16,000, so the remaining $5,000 takes 5/16 of that year. The payback period is 3.3 years, or exactly 3.3125 years.
Discounted at 10%, the same cash flows are worth less, and the discounted payback is 4.3 years, 0.9 years longer. The NPV at 10% is $12,095.30.
Against a 4 years cutoff, the project passes on simple payback but fails on discounted payback.
If the same $50,000 instead returned an even $12,500 a year for six years, the payback would be 4.0 years and the discounted payback 5.4 years. Raising the discount rate in the first example to 15% stretches the discounted payback to 5.1 years, while the simple payback stays at 3.3 years.
Reading the cumulative chart
The solid line starts at minus the investment and climbs by each year’s cash flow. The dashed, discounted line climbs more slowly, and the gap widens every year because later dollars are discounted more heavily. Where the solid line ends is the project’s net cash ($35,000.00 in the example); where the dashed line ends is its NPV. A dashed line that finishes below zero means the project never earns the discount rate, however short the simple payback looks.
What payback ignores
Payback answers one question well: how long is the money at risk? It is weak as a measure of value, for two reasons.
It ignores the time value of money. Simple payback treats a dollar in year 4 as equal to a dollar today. Discounted payback fixes this, which is why it is always longer when the discount rate is positive.
It ignores everything after the cutoff. Cash that arrives after the payback point does not count at all. Compare two $50,000 projects under a three-year cutoff:
| Quick project | Slow-starting project | |
|---|---|---|
| Cash flows | $25,000, $25,000, $5,000 | $5,000, $10,000, $20,000, $40,000, $50,000, $50,000 |
| Payback | 2.0 years | 3.4 years |
| Discounted payback at 10% | Never | 3.8 years |
| NPV at 10% | -$2,855.00 | $64,426.51 |
| Meets a 3-year cutoff | Simple payback only | No |
The payback rule accepts the quick project and rejects the slow one. Yet the quick project never covers its cost once the cash is discounted, while the slow one adds $64,426.51 of value. Discounted payback deals with the first flaw but not the second: it still ignores cash after the cutoff. Use it as a liquidity and risk screen, then decide on NPV.
When payback is a useful measure
- Cash-constrained businesses that need money back quickly to fund the next project.
- Fast-changing markets, where cash forecast five years out is unreliable and an early payback limits the exposure.
- Small, routine decisions, such as an energy-saving upgrade, where a full NPV is more effort than the decision deserves.
What this calculator does not include
- Timing within the year. The fractional year assumes cash arrives evenly. If most of a year’s cash comes at the end, the true payback is later.
- Later costs. If a large cost after the payback point turns the cumulative total negative again, the calculator flags it, but reports the first time the total reaches zero.
- Taxes and working capital must already be included in the cash flows you enter.
- Value. Payback says nothing about how much a project earns. Use the NPV calculator and the IRR calculator for that.