Corporate Finance

Question 1

Payback period

Answer 1

Payback period is the number of years it takes to recover the initial cost of an investment

Payback period = full years until recover + (unrecovered cost at the beginning of recovery year)/(cash flow during recovery year)

(E.g. in the picture attached, payback period = 2 + 25/75

Question 2

Discounted payback period

Answer 2

The discounted payback period uses the present values of the project’s estimated cash flows. It is the number of years it takes a project to recover its initial investment in present value terms and, therefore, must be greater than the payback period without discounting.