Question

Payback period is:

a. That point in time when costs are finally more than offset by revenues
b. A key measure of return on investment
c. The value of future cash flows (e.g., revenues, costs) assessed

Answer 1

The payback period is the duration required to recover the cost of an investment from its cash flows. It's a straightforward calculation, but does not account for actual rates of return or present discounted values past the payback time frame.

Step-by-step explanation:

The payback period is a financial metric used to determine the time it takes for an investment to generate enough cash flow to recover the original investment cost. It's a simple calculation that divides the initial investment by the annual cash inflow. For example, if you spend $1,000 on insulation to save $100 annually on energy costs, the payback period would be 10 years ($1,000 / $100 annually).

Decisions in business and finance are often made based on the payback period because it provides a quick assessment of an investment's risk and liquidity. An acceptable payback period varies across different industries and philosophies; some businesses may require a payback period as short as two years.

While helpful, the payback period should not be the sole measure of an investment's worth, as it does not account for the actual rate of return, including capital gains or the present discounted value of future cash flows beyond the payback period.