Payback Analysis: Formula & Example

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  • 0:01 What Is Payback Analysis?
  • 0:54 Formula
  • 1:28 Example
  • 2:44 Lesson Summary
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Lesson Transcript
Instructor: Shawn Grimsley

Shawn has a masters of public administration, JD, and a BA in political science.

Payback analysis is an important financial decision-making tool. In this lesson, you'll learn what it is and how to apply the formula, and you'll see an example of payback analysis. You'll also have a chance to take a short quiz after the lesson.

What Is Payback Analysis?

Payback analysis is a mathematical methodology to determine the payback period for an investment. The payback period is how long it will take to pay off the investment with the cash flow derived from the asset or project. In colloquial terms, it calculates the 'break even point.' The payback period is usually measured in fractions of years.

Payback analysis can provide important information for decision-making. It provides a means to manage risk. You can use payback analysis to determine whether an asset or project will pay for itself in an acceptable period of time. Shorter payback periods are usually viewed as less risky. Additionally, you can also use the method to compare potential assets or projects to see which will recoup its costs quicker. The payback method is certainly not the only financial metric that should be relied upon when making an investment decision, but it is a useful tool.


Now, let's take a look at the formula necessary for payback analysis. The payback formula is simple. The payback period is the total investment required to purchase the asset or fund the project divided by the net annual cash flow, which is gross cash flow minus expenses, generated from the asset or project.

The formula is:

Payback Period = Initial Investment / Annual Net Cash Flow

Now that we know the formula, let's take a look at an example and use our payback formula.

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