When the cash flows associated with an investment project change from year to year, the payback period must be calculated by tracking the unrecovered investment year by year.
The payback period is the amount of time required to recover the cost of an investment or to reach the breakeven point for an investor.
Shorter payback periods indicate more appealing investments, whereas longer payback periods indicate less desirable investments.
The payback period is determined by dividing the investment amount by the annual cash flow.
Account and fund managers consider the payback period when deciding whether to proceed with an investment.
One disadvantage of the payback period is that it ignores the time value of money.
Hence, the payback period must be calculated by tracking the unrecovered investment year by year.
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