## Payback Period

The payback period is the length of time required for cumulative net cash inflows to equal the initial cash outlay - i.e., the time to recover the money invested.

Steps:

1. Determine total initial capital investment (cash outflow).

2. Estimate annual after-tax cash inflows over the project's life.

### i. Uniform Cash Flows

```

Payback period = Total initial capital investment / Annual after-tax cash inflow

```

Note: cash inflow = Profit after tax + Depreciation (depreciation is added back as it is non-cash).

### ii. Non-Uniform Cash Flows

Build a cumulative cash inflow column year by year. The payback period is the year where cumulative inflows equal the initial outlay. If no exact match, identify the year it falls in and compute the fraction:

```

Fraction of year = Balance cash outlay / Cash inflow during that year

```

Worked example

### Example 1

Uniform cash flows: Project costs Rs.20,00,000, annual profit Rs.3,00,000 after dep @12.5% SLM but before 50% tax.

```

Profit before tax 3,00,000

Less: Tax @50% 1,50,000

Profit after tax 1,50,000

Add: Depreciation 2,50,000

Total cash inflow 4,00,000

```

Payback = 20,00,000 / 4,00,000 = 5 years.

### Example 2

Non-uniform cash flows: Outlay Rs.2,00,000.

Year	Inflow	Cumulative
1	80,000	80,000
2	60,000	1,40,000
3	60,000	2,00,000
4	20,000	2,20,000

Cumulative equals outlay at end of year 3 -> payback = 3 years.

If outlay were Rs.2,05,000: Rs.2,00,000 recovered in 3 yrs; balance Rs.5,000 in year 4.

Fraction = 5,000 / 20,000 = 1/4 year -> payback = 3.25 years.

⚠️ Common exam mistakes

Using profit after tax alone as the annual cash inflow - depreciation must be added back.
Forgetting to convert pre-tax profit to post-tax before adding depreciation.
Computing the year-fraction incorrectly - use Balance outlay / inflow of the recovery year.
Selecting projects on payback alone - it ignores cash flows after the payback point and the time value of money.

Reference:

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Payback Period (uniform & non-uniform cash flows)

Worked example

⚠️ Common exam mistakes