Payback Period Calculator
Calculate simple and discounted payback period for any investment. Includes year-by-year cumulative cash flow table and ARR calculation.
Simple Payback Period
Discounted Payback Period
Accounting Rate of Return (ARR)
ARR = Average Annual Profit / Initial Investment × 100
What is the Payback Period?
The payback period is the length of time it takes for a capital investment to generate enough net cash inflows to recover its initial cost. It is one of the most widely used capital appraisal techniques, particularly popular with smaller businesses and in situations where liquidity is a priority consideration. The calculation is intuitive and requires no specialist finance knowledge: you simply track cumulative cash inflows year by year until they equal the upfront cost.
For equal annual cash flows:
E.g. £60,000 ÷ £15,000 per year = 4 years
Simple vs Discounted Payback Period
The simple payback period treats all cash flows equally regardless of when they occur. This is its major weakness: money received in year 5 is treated as identical in value to money received in year 1, even though inflation and opportunity cost mean that distant cash flows are worth less in real terms.
The discounted payback period corrects this by applying the time value of money. Each year's cash flow is divided by (1 + discount rate)^n before being added to the cumulative total. The discount rate is typically the company's Weighted Average Cost of Capital (WACC) or a hurdle rate. Because discounting reduces the value of future flows, the discounted payback period is always longer than the simple version.
Worked Example
A machine costs £40,000. It generates the following annual cash flows: Year 1: £8,000; Year 2: £12,000; Year 3: £15,000; Year 4: £18,000. Discount rate: 10%.
Simple payback: After Year 3 cumulative = £35,000 (still £5,000 short). In Year 4 we need £5,000 of the £18,000. Payback = 3 + (5,000/18,000) = 3.28 years (3 years and 3.3 months).
Discounted payback: Year 1 DCF = £8,000/1.10 = £7,273. Year 2 DCF = £12,000/1.21 = £9,917. Year 3 DCF = £15,000/1.331 = £11,269. Cumulative after 3 years = £28,459. Year 4 DCF = £18,000/1.4641 = £12,294. Need £11,541 more. Discounted payback = 3 + (11,541/12,294) = 3.94 years.
Advantages of Payback Period
Despite its limitations, the payback period remains popular for several good reasons. It is simple to calculate and easy to communicate to non-financial managers. It focuses on liquidity, which is particularly important for small businesses with constrained cash flow or for projects in rapidly changing industries where market conditions can shift before a long payback period expires. It also effectively measures risk in a basic sense: projects with shorter payback periods are exposed to market uncertainty for less time.
Disadvantages and Limitations
The primary limitation of the simple payback period is that it ignores the time value of money: a £10,000 cash flow in year 1 and year 5 are treated identically. It also ignores all cash flows after the payback point, which means a project with a 3-year payback but 10 more years of highly profitable operation looks the same as one that generates nothing after year 3. It does not measure profitability or return: two projects can have identical payback periods but very different NPVs.
Payback Period in Capital Budgeting
Most organisations use payback period as one input among several when evaluating capital projects. It typically sits alongside Net Present Value (NPV), Internal Rate of Return (IRR), and Accounting Rate of Return (ARR) in a comprehensive capital appraisal. The payback period screens out projects that take too long to recover the investment (a "maximum payback period" or hurdle); NPV then determines which of the qualifying projects adds the most value.
In ACCA and AAT examinations, payback period is a core component of the investment appraisal topic. Students are expected to calculate both simple and discounted payback period, state the decision rule (choose the project with the shorter payback period, provided it meets the maximum payback criterion), and critically evaluate the method's strengths and limitations.
Typical Payback Period Benchmarks by Sector
| Sector / Project Type | Typical Payback Period |
|---|---|
| Software / SaaS investment | 6 months – 2 years |
| Manufacturing equipment | 3 – 7 years |
| Commercial property | 8 – 15 years |
| Residential property (UK) | 10 – 25 years |
| Solar panels (domestic UK) | 7 – 15 years |
| Wind energy project | 5 – 12 years |
| Business acquisition | 3 – 8 years |
Payback Period for Solar Panels in the UK
Domestic solar panel installation in the UK typically costs £5,000 to £9,000 for a 3.5kWp to 6kWp system. Annual savings from reduced electricity bills and Smart Export Guarantee (SEG) payments typically range from £600 to £1,200 per year depending on consumption, export rate, and sunlight. This gives a simple payback period of 7 to 15 years. Most quality panels carry 25-year performance warranties, so the investment generates returns well beyond the payback point.
Accounting Rate of Return (ARR)
ARR is a related capital appraisal technique that measures profitability as a percentage. ARR = (Average Annual Profit / Initial Investment) x 100. Unlike payback period, ARR considers the entire life of the project and is expressed as a percentage that can be compared to a minimum required rate of return. Its weakness is that, like simple payback, it ignores the time value of money.