What is the payback period?
The payback period is how long it takes for the cash an investment brings in to equal what it cost. If a $50,000 project brings in $12,000 a year, growing a little each year, it pays for itself in about 4 years.
- Simple payback – adds up the yearly cash inflows until they cover the cost.
- Discounted payback – first converts each future dollar to today's value using a discount rate, so it takes longer and gives a more realistic answer.
Using payback wisely
- A shorter payback means less risk and your money comes back sooner.
- Payback ignores everything after the break-even point, so a project with a longer payback can still earn more in total.
- Combine it with NPV or IRR for bigger decisions.
Frequently asked questions
What is a good payback period?
It depends on the investment and its risk. Many small businesses aim for a few years; long-lived assets like solar panels often have longer paybacks.
What discount rate should I use?
Use your cost of borrowing or the return you could earn on another investment with similar risk.
How do I calculate payback for solar panels?
Use the installed cost after tax credits and rebates as the investment, and your yearly electricity savings as the cash inflow.