ENGR 3360U Winter 2014

Unit 5.5
Payback Period Analysis
Dr. J. Michael Bennett, P. Eng., PMP,
UOIT,
Version 2014-I-01

Unit 5 Present Worth Analysis

Change Record
2014-I-01 Initial Creation
Text Chapter 5

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2014-I-01

Dr. J.M. Bennett, P.Eng., PMP ENGR 3360U Eng Eco

Unit 5 Present Worth Analysis

5.5 Payback Period Analysis

Also call payout analysis
Extension of present worth method
Two forms:
1.
2.

With no interest -- i = 0% (no-return payback)

With an assumed interest rate -- i > 0% (discounted
payback analysis)

Technique: estimates the time np to recover the

initial investment in a project, either with or
without interest earned

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2014-I-01

Dr. J.M. Bennett, P.Eng., PMP ENGR 3360U Eng Eco

Unit 5 Present Worth Analysis

Payback Period Analysis-RULE

Never use payback analysis as the
primary means of making an
accept/reject decision on an alternative!
Best used as a screening technique or preliminary analysis tool
Historically, this method was a primary analysis tool and often
resulted in incorrect selections
To apply, the cash flows must have at least one (+) cash flow in
the sequence

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Dr. J.M. Bennett, P.Eng., PMP ENGR 3360U Eng Eco

Unit 5 Present Worth Analysis

Basic Formula for Payback Analysis

Determine the number of
years np that it takes for all
negative net cash flows to
exactly equal all positive
cash flows

t n p

0 P NCFt ( P / F , i %, t ).
t 1

If i = 0% and all NCF

estimates are the same, the
payback calculation
np = P/NCF
simplifies to

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2014-I-01

Dr. J.M. Bennett, P.Eng., PMP ENGR 3360U Eng Eco

Unit 5 Present Worth Analysis

Payback - Interpretations and Fallacies

Common managerial philosophy is that a shorter payback is preferred to a longer
payback period; this is not a good approach from economic vantage
Not a preferred method for final decision making better as a screening tool
Ignores all cash flows after the payback time period
May not use all of the cash flows in the cash flow sequence.

Dont use no-return (i = 0%) payback for final

decisions. It

Neglects any required return on the investment

Neglects all cash flows after time np including any positive cash
flows that contribute to making a positive return on the investment

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2014-I-01

Dr. J.M. Bennett, P.Eng., PMP ENGR 3360U Eng Eco