4.2 The Payback Period

This method aims to answer a question of how long it takes the project to “pay back” its initial investment．That is，the Payback Period equals to the number of years to recover initial costs．If the net cash flows of each year are the same after the project is completed，the calculation formula of the investment payback period is as follows：

P _t ＝K/A，

where K refers to the initial costs and A refers to the net cash flows of each year during the investment period．

If the net cash flows of each year are different before the project is completed，the calculation formula of the investment payback period is：

P _t ＝（The year when the cumulative net cash flows are positive for the first time-1）＋Investment not recovered at the beginning of the year÷Net cash flows of the year.

Given the previous example of restaurant investment，the investment payback period of the restaurant is 2.33.

4.2.1 Selecting Criteria

The principle of using the payback period method to analyze the project capital budget is：

1．Single project（单一项目）

Accept the project if it pays back within the specified time．

2．Mutually exclusive projects（互斥项目）

Select alternative with the shortest payback period．

4.2.2 Why Use Payback Period？

The advantages and disadvantages of the payback period method mainly include：

1．Advantages

（1）Easy to understand．

（2）Biased toward liquidity．

2．Disadvantages

（1）Ignores the time value of money．

（2）Ignores cash flows after the payback period．

（3）Biased against long-term projects（R＆D）．

（4）Requires an arbitrary acceptance criteria．

（5）A project accepted based on the payback criteria may not have a positive NPV． FmfpvC5LWWX5JL+B4ZhWPNO5uRODtNa8/VdrosN7kf0HuVan2L2lFRaAqtYOLZLT