How is the pay-back period calculated?

How is the pay-back period calculated?

• A. By dividing the total investment by the annual profit
• B. By determining the time taken for cumulative net annual profit to equal the initial investment
• C. By subtracting cumulative costs from revenue
• D. By averaging the net profit over the project's lifespan

Answer: (B)

The payback period is a financial metric used to evaluate the time it takes for an investment to generate an amount of income equal to the initial investment. This is calculated by determining the time required for cumulative net annual profit to equal the initial investment. In practical terms, this involves tracking the annual cash inflows from the investment, subtracting any annual costs, and accumulating these net profits over time. Once the total of these cumulative net profits matches the original investment amount, the duration taken to reach that point is the payback period. This method is particularly useful for assessing how quickly an investment recoups its costs, providing insight into the risk and liquidity associated with the project. The focus on cumulative cash inflows over specific time frames differentiates this approach from other financial metrics, establishing a clear timeline for return on investment.

The payback period is a financial metric used to evaluate the time it takes for an investment to generate an amount of income equal to the initial investment. This is calculated by determining the time required for cumulative net annual profit to equal the initial investment.

In practical terms, this involves tracking the annual cash inflows from the investment, subtracting any annual costs, and accumulating these net profits over time. Once the total of these cumulative net profits matches the original investment amount, the duration taken to reach that point is the payback period.

This method is particularly useful for assessing how quickly an investment recoups its costs, providing insight into the risk and liquidity associated with the project. The focus on cumulative cash inflows over specific time frames differentiates this approach from other financial metrics, establishing a clear timeline for return on investment.