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discounted payback period

Also called: discounted payback

How long it takes for discounted cash flows to repay the investment. Like any payback measure, it ignores everything that happens afterwards.

The payback period is how long it takes for a project's cash to return the investment: add up the yearly cash until the running total reaches zero. The discounted payback period does the same with each year's cash in today's money, divided by (1 + r)ᵗ, so it also counts the cost of waiting. It is always longer than simple payback, and a project that never pays back in today's money has a negative NPV.

Both are usually stated in years with a fraction, assuming the cash comes in evenly within the year: if 166,400 is still missing at the end of year 3 and year 4 brings 327,680 in today's money, payback is 3 + 166,400 ÷ 327,680 = 3.51 years.

Payback answers a real question: how long is the money at risk, and how long must the company fund the gap? It does not say how much value a project creates. Everything after the payback point is ignored, so a quick project that stops there can look better than a slower one that keeps paying for years. Use it beside NPV, never instead of it.

Example

Klasna's maths mock-exam mode costs 1,200,000 UAH and brings 300,000, 600,000, 800,000 and 800,000. At 25%:

Year
Cash
Running total
In today's money
Running total
0
−1,200,000
−1,200,000
−1,200,000
−1,200,000
1
300,000
−900,000
240,000
−960,000
2
600,000
−300,000
384,000
−576,000
3
800,000
500,000
409,600
−166,400
4
800,000
1,300,000
327,680
161,280

Simple payback: 2 + 300,000 ÷ 800,000 = 2.38 years. Discounted: 3 + 166,400 ÷ 327,680 = 3.51 years. The parent progress app (−600,000, then 400,000 and 300,000) pays back in 1.67 years, but in today's money it ends at −88,000 and never pays back at all.

Common mistakes

  • Choosing the project with the shortest payback. It can be the one with a negative NPV; payback says nothing about what comes after.
  • Stopping at simple payback. Without discounting, a long wait looks free.
  • Counting sales instead of cash contribution. Payback on revenue looks several times faster than payback on what the customer actually leaves.
  • Putting cash on the wrong dates. Late-paying clients push payback out; prepaid packages pull it in.
  • Treating the fraction as precise. "3.51 years" assumes cash spread evenly within the year.

Learn it in the course