TABLE OF CONTENTS The payback may be defined as the amount of time, usually expressed in years and months, required for the original investment amount to be repaid by the cash-in flows. This measure is sometimes used with nominal cash-in flows and sometimes used with discounted cash-in flows. Nominal cash flows are the amounts unadjusted for the time value of money. The most popular form of payback used today is referred to as the exhaust method. The exhaust method of payback calculation involves the deduction of each year s cash-in flow from the original investment until the original amount is reduced to zero. This method should be contrasted with the average payback method which only gives a rough approximation of the period of time required to recover the investment amount when the cash-in flows are relatively constant.
The calculation of the payback by the exhaust method is a reiterative process which requires the cumulative benefit to be subtracted from the investment until the result is zero. The time at which the result is zero represents the period that is required for the investment amount to be returned.
If there is any substantial variability in the annual benefits this method will produce meaningless results. Many organizations use the payback as the primary criterion for deciding whether an investment is suitable or not.
It is generally considered that the cash flows used to calculate the payback should have first been discounted. This is referred to as a discounted payback. If this...
