Principles of Managerial Finance, 15th Edition

10.2 Payback Period

1. LG2

Small and medium-sized firms often use the payback period approach to evaluate proposed investments. The payback period is the time it takes an investment to generate cash inflows sufficient to recoup the initial outlay required to make the investment. In the case of an annuity (such as the Bennett Company’s project A), you can calculate the payback period by dividing the initial investment by the annual cash inflow. For a mixed stream of cash inflows (such as project B), simply add up the yearly cash inflows until the accumulated sum equals (or exceeds) the initial investment.

Many firms use the payback period because it is simple to calculate and to understand. Unfortunately, the payback method has some serious ...