The payback period is the time it takes for an investment to generate enough cash flows to recover the initial investment cost.

How it’s calculated:

• Uniform cash flows: Payback Period = Initial Investment / Annual Cash Flow
• Variable cash flows: Add up each year’s cash flow until the cumulative amount equals or exceeds the initial investment

Interpretation:

• Shorter payback periods are generally preferred as the investment risk is lower
• This method ignores cash flows beyond the payback period and the time value of money
• Use in combination with other metrics like NPV and IRR for better decision making