What's a good payback period?

Depends on the investment type. Business projects: <3 years is good. Solar panels: <5-7 years. Real estate: <10 years. Shorter is always better.

Limitation of payback period?

Ignores time value of money and cash flows after the payback period. A project with 3-year payback giving ₹10Cr in year 4 looks the same as one giving ₹1L.

Payback Period Formula

Q: Limitation of payback period?

Ignores time value of money and cash flows after the payback period. A project with 3-year payback giving ₹10Cr in year 4 looks the same as one giving ₹1L.

The payback period is the time it takes for cumulative cash flows to equal the initial investment. Shorter payback = lower risk.

Simple Payback Period

Payback Period = Initial Investment / Annual Cash Flow

Where:

I = Initial investment amount
CF = Annual cash flow (if uniform)

Step-by-Step:

1
Identify initial investment
Total upfront cost of the project.
2
Estimate annual cash flows
Expected net cash inflow each year.
3
Divide
If cash flows are uniform: I / CF. If uneven: find the year when cumulative CF exceeds investment.

Worked Examples:

Solar panel installation

Investment: ₹3LAnnual Savings: ₹60,000

Result: 5 years

3,00,000 / 60,000 = 5 years payback period