Calculating the Project Payback Period
How long does it take the project to pay back the costs of the project?
For example, the XYZ Project will cost the organisation $500,000 to create over five years. The expected cash inflow (income) on the project deliverable, however, is $40,000 per quarter.
From here it’s simple math: 500,000 divided by $40,000 is 12.5 quarters, or a little over three years to recoup the expenses. This selection method, while one of the simplest, is also the weakest. Why? The cash inflows are not discounted against the time it takes to begin creating the cash. This is the time value of money.
The $40,000-per-quarter five years from now is worth less than $40,000 today.
Considering the Discounted Cash Flow
Discounted cash flow accounts for the time value of money.
If you were to borrow $100,000 for five years you’d be paying interest on the money. If the $100,000 were invested for five years and managed to earn six-percent interest per year, compounded annually it’d be worth $133,822.60 at the end of five years.
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