Microlesson · 5-min read

Payback Reciprocal

## Payback Reciprocal

The payback reciprocal is the reciprocal of the payback period, used as a quick approximation of the Internal Rate of Return (IRR).

Why it exists: A drawback of the payback method is that it gives no cut-off rate for decisions. The reciprocal helps estimate a rate of return.

```

Payback Reciprocal = Average annual cash inflow / Initial investment

```

Validity conditions - the reciprocal closely approximates IRR only when:

Worked example

### Example 1

Initial investment Rs.20,000; annual cash inflow Rs.4,000; life 10 years.

```

Payback reciprocal = 4,000 / 20,000 x 100 = 20%

```

Since life (10 yrs) is more than twice the payback (5 yrs) and inflows are uniform, 20% is a reasonable approximation of the IRR.

Applying the reciprocal as an IRR estimate when inflows are uneven or project life is less than twice the payback - the approximation fails.
Inverting the formula (using Initial investment / Average inflow, which is just the payback period).

Reference:

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