Understanding Payback period analysis

With every investment made, you’ll want to know the payback period that is how long it will take to recoup the costs of the investment and start reaping benefit of the investment made.

Payback period can be calculated, divide the total amount of the investment by the annual savings or new revenues expected.


EXAMPLE

KJTL manager expect the $100,000 robot to save the company $18,000 a year. They calculate the payback period as follows:

$100,000 [cost of the robot] ÷ $18,000 [the annual savings] = 5.56 years

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KJTL won’t truly start reaping the benefits of its robot investment for more than five years. But what if the life-span estimates are wrong and the robot wears out soon after five years? The investment now appears a bit riskier certainly more so than an investment with a similar ROI and a payback period of three years.


That’s why it’s important to do the analysis using a range of assumptions. Consult with your organization’s finance department to get a sense of what they would consider conservative and aggressive in their scenario planning. And also research and prepare your business case for the investment in details.

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Categories: Personal Finance

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