Payback period is defined as 

the number of years required to recover the original cash

investment. In other words, it is the period of time at the end of which a machine, facility,
or other investment has produced sufficient net revenue to recover its investment costs.
The Payback Period shows how long it takes for a business to recoup an investment.
This type of analysis allows firms to compare alternative investment opportunities and
decide on a project that returns its investment in the shortest time if that criteria is
important to them.
Written out as a formula
:Payback Period = Initial Investment / Annual Payback

For example, imagine a company invests $200,000 in new manufacturing equipment

which results in a positive cash flow of $50,000 per year.

Payback Period = $200,000 / $50,000

In this case, the payback period would be 4.0 years because 200,0000 divided by

50,000 is 4.

The management of Health Supplement Inc. wants to reduce its labor cost by installing
a new machine. Two types of machines are available in the market – machine X and
machine Y. Machine X would cost $18,000 where as machine Y would cost $15,000.
Both the machines can reduce annual labor cost by $3,000.

Required: Which is the best machine to purchase according to payback method?

Solution:

Payback period of machine X: $18,000/$3,000 = 6 years

Payback period of machine Y: $15,000/$3,000 = 5 years

According to payback method, machine Y is more desirable than machine X because it

has a shorter payback period than machine X.

The best payback period is the shortest one possible. Getting repaid or recovering the
initial cost of a project or investment should be achieved as quickly as it allows.
However, not all projects and investments have the same time horizon, so the shortest
possible payback period needs to be nested within the larger context of that time
horizon. For example, the payback period on a home improvement project can be
decades while the payback period on a construction project may be five years or less.