The payback is the time required to recover the initial investment cost. Expressed in years, evaluating investment opportunities and associated risks is a quick and straightforward method. A shorter payback period generally makes the investment more attractive. In practice, people often refer to the payback as the time it takes to "get our bait back" or recover the initial funds put into the project.
For example, suppose Sarah opens a restaurant with an initial investment of $50,000 and earns $5000 annually. In that case, the payback period is calculated by dividing $50,000 by $5,000, resulting in a payback period of 10 years. Similarly, businesses use the payback period to evaluate investments like purchasing equipment or launching new projects, especially when seeking a fast investment return.
However, the payback period has limitations, as it doesn't factor in the time value of money, potential earnings after the payback period, or the project's overall profitability.
From Chapter 7:
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