Payback Period Calculation | CFA Level 1 Exam Prep

Payback Period Calculation

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A project requires an initial outlay of $600. Over the next 5 years, it expects to have cash outflows of $200, $300, $175, $350 and $150. The revenues over the same period equal $100, $400, $700, $550 and $800. Assume that these cash flows occur at year-end. The project's payback period equals ________.

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The payback period is defined as the expected number of years that would be required to recover the original investment. In particular, Payback period = Years before full recovery + (unrecovered cost at the start of payback year)/(net cash flow in the payback year) To calculate the payback period, you must have the stream of net cash flows = Revenues - out flows. The net cash flows over the next 5 years are $(100-200), $(400-300), $(700-175), $(550-350) and $(800-150) i.e. the net cash flows are: -$100, $100, $525, $200 and $650. The complete recovery of the total outlay of $600 + $100 (year 1 net outflow) occurs in the 4th year. At the beginning of the 4th year, the outstanding balance equals 600+100-100-525 = $75. Therefore, payback period = 3 + 75/200 = 3.375 years.

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