Payback period: value and general principles of calculation

When deciding whether to invest in a projectpotential investors evaluate a combination of factors. This is the situation in the investment and financial market, and the investor's experience in a specific area, and the geopolitical situation in the region, and much more. One of their important indicators is the payback period. It is the period during which the net profit takes a positive value. In other words, it shows the time for which the initial investment will pay off. The starting point is either the actual commencement of transactions, or the moment of initial investment. Of course, every investor is interested in ensuring that the payback period of the project is as short as possible. However, this parameter should be considered in conjunction with such indicators as, for example, the level of risk. For projects with a high level of risk, the payback period should be shorter, because the investor risks not only his own, but also borrowed funds. It is especially important that this period is not large, if initially limited funds are directed, for example, to the modernization of aging production.

Determination of the estimated payback period, thenthere is an achievement of the break-even point, is not a labor-intensive process, and this is a great advantage of this method of assessing the investment attractiveness of the project. However, it does not take into account the distribution of invested funds and many other factors, which does not allow for a high degree of accuracy to assess profitability. Nevertheless, with the initial evaluation of the attractiveness of several projects, they are often compared precisely by the payback period.

In the Soviet-era economy,term "payback period of capital investments", that is, the period for which the effect of production costs is achieved. This effect can be profit, as well as cost reduction, if we consider a single enterprise. We apply this term both to the industry and to the country as a whole, then the effect is understood as the increment of the national income. The effectiveness of the same project is determined based on whether the regulatory payback period is met or not.

How is the payback period calculated?analyzed project? Currently, there are several approaches. The choice depends on whether the amount of money received from the project is the same by year, and also whether the variable value of cash is taken into account in the calculation.

1. The simplest case - when it is assumed that the proceeds from the implementation of the investment project will be the same for all future years. Then the payback period (abbreviated PP, from the English Payback Period) is calculated using the simple formula PP = I / CF. Here I is the total volume of investments, and CF is the average annual income.

2. A phased method of calculation is used for uneven cash receipts from the project. The principle of calculation is the same, but the total number of periods and receipts is separately calculated.

3. If you take into account the change in the value of money over the years of project implementation, then talk about the discounted payback period. Discounting is the calculation of the present value of funds that are expected to be received in the future. The calculation is made taking into account the discount rate, which is determined on the basis of a risk-free rate with subsequent consideration of all risks. The discount rate can also be calculated based on the internal rate of return, interest on borrowed capital, etc.

Let's generalize the told: payback period is an important criterion that helps quickly compare the investment attractiveness of several projects, but it can not be a reliable indicator of profitability and reliability of investments.