Payback period
Work out how long a project takes to repay its initial outlay, on both undiscounted and discounted cash flows. The interpolation inside the crossing year is shown explicitly so the fraction of a year is never a guess.
| Year | Cash flow | Cumulative CF | Discounted CF | Cumulative DCF |
|---|---|---|---|---|
| Year 0 | -$120,000 | -$120,000 | -$120,000 | -$120,000 |
| Y1 | $25,000 | -$95,000 | $22,727 | -$97,273 |
| Y2 | $30,000 | -$65,000 | $24,793 | -$72,479 |
| Y3 | $35,000 | -$30,000 | $26,296 | -$46,183 |
| Y4 | $40,000 | +$10,000 | $27,321 | -$18,863 |
| Y5 | $45,000 | +$55,000 | $27,941 | +$9,079 |
Recovery is interpolated inside the crossing year, so a payback of 3.4 years means the outlay is repaid four months into year four.
CumCFₜ = −C₀ + Σᵢ≤ₜ CFᵢ · nominal recovery test
PB = t* + |CumCFₜ*| / CFₜ*₊₁ · linear interpolation inside the crossing year
PVₜ = CFₜ / (1+r)ᵗ · the same test on present values
PB ≤ target · payback ignores cash flow after the cut-off
A clear path from inputs to results.
Payback answers a different question from NPV: how long is my money at risk before it comes back? This engine runs the test twice — on raw cash flows and on flows discounted at your hurdle rate — so you can see how much of the recovery depends on distant, uncertain years.
How to use
- Enter the initial outlay committed at time zero.
- Set the discount rate used for the discounted version of the test.
- Fill in the five annual cash flows. A slow first year pushes payback out sharply.
- Read the simple payback first: it is the year in which cumulative cash turns positive.
- Compare it with the discounted payback. A large gap means most recovery sits in later years.
- Check the surplus at year five to see how much cushion exists beyond mere recovery.
The formula
Reference: Brealey, Myers & Allen, "Principles of Corporate Finance", ch. 5 (payback as a screening rule).
Worked example
Five-year project, 10% hurdle rate (default inputs)
- Initial outlay $120,000.
- Cash flows: $25,000, $30,000, $35,000, $40,000, $45,000.
- Discount rate 10%.
- 1
Cumulative nominal cash: −95,000, −65,000, −30,000, +10,000, +55,000.
- 2
The sign changes in year four, with 30,000 still outstanding at the end of year three.
- 3
Divide the shortfall by year four’s flow: 30,000 / 40,000 = 0.75 of a year.
- 4
Simple payback is therefore 3.75 years.
- 5
Discounting the flows at 10% pushes the crossing into year five: 4.69 years.
Simple payback 3.75 years · discounted payback 4.69 years · surplus at year five $55,000.
Interpreting the result
Payback is a liquidity and risk screen, not a value measure. It ignores every cash flow after the cut-off, so a project that pays back in three years and then earns nothing for a decade looks identical to one that pays back in three years and earns for twenty. Use it to filter out projects that keep capital tied up too long, then rank the survivors on NPV.
Assumptions & limitations
- Cash flows are assumed to arrive evenly through the crossing year, which is what the linear interpolation encodes.
- The outlay is entirely at time zero. Staged investment needs a cumulative-outlay version of the model.
- Nothing after the payback date is counted — that is the definition, not an oversight.
- The five-year horizon truncates the analysis; a project that never pays back within it is reported as beyond horizon.
- Tax, financing and working capital are not separated; fold them into the cash flows.
Frequently asked questions
Why is discounted payback longer than simple payback?
Discounting shrinks each future cash flow, so it takes more of them to recover the same outlay. The gap widens as the discount rate rises and as more of the recovery sits in later years.
Why do finance textbooks dislike payback?
Because it ignores the time value of money (in its simple form) and ignores all cash flows after the cut-off. Two projects with the same payback can have wildly different NPVs. It survives because it is intuitive and captures exposure time.
How does salvage value affect payback?
A terminal value in the final year can rescue a project that otherwise never pays back within the horizon. Treat that as a warning sign: the recovery depends entirely on a resale assumption.
What is a good payback period?
It depends on the asset life and the sector. A rule of thumb is that payback should be well inside the asset’s useful life — a five-year payback on a three-year asset never happens. Capital-intensive industries often accept longer paybacks than software.
Can payback be used with uneven cash flows?
Yes — that is exactly what the cumulative column handles. The interpolation only assumes the crossing year’s flow arrives smoothly, which is a reasonable approximation for monthly revenue.
What if cumulative cash never turns positive?
The project never repays its outlay inside the five-year window. That is reported explicitly rather than as a number, because inventing a payback beyond the data would be false precision.
Methodology last reviewed 2026-10-18. Results are informational and not financial or engineering advice — see our disclaimer.