| Table 3.1: Payback Period for Project A ($) | ||
| Year | Payback | Net Cash Flow |
| 0 | (1 000 000) | (1 000 000) |
| 1 | (900 000) | 100 000 |
| 2 | (750 000) | 150 000 |
| 3 | (500 000) | 250 000 |
| 4 | (200 000) | 300 000 |
| 5 | 50 000 | 250 000 |
| 6 | 250 000 | 200 000 |
| 7 | 450 000 | 200 000 |
Thus, Payback in exactly 4 years and 9.6 months.
This is the official layout the IB wants you to follow. So, whenever you have to present payback period, present it like this!
What do all these numbers mean?
Net cash flow column will be given to you in the case study. It is the cash flow the business over the years. Payback column is what you use to calculate in what time the project will be repaid. You start with 0 (year in which business purchased project A) and the number is negative as that represents expenditure. In this case, it cost $500.000. We use brackets to indicate that it is a negative number. In year 1, it is expected that the business will have a cash influx of $100.000 – so, what we do is simply add that to the initial expenditure. We repeat this over and over again until we reach a year under the ‘payback’ column that’s positive or zero. This means that in that year, with the expected cash influx given, we have repaid investment in full (in our example, that is year 4). Now we know that we expect to repay project A in year 4, but we do not know in exactly how many months. So, we divide the ‘payback’ amount for that year by the expected cash flow for that year (in this case these are numbers 0 and 150). We then multiply all this by 12. In our case, the payback period is exactly 4 years and 9.6 months.
If we used this method to appraise different investment projects, we would choose the investment that pays back the fastest.