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What is capital budgeting? What is the accounting rate of return (ARR)? What is the profitability index (PI)? What is the difference between capital and revenue expenditure in budgeting? Why is the initial investment treated as a time-zero cash outflow? What are the advantages and disadvantages of the payback method? What is a hurdle rate? What is the difference between mutually exclusive and independent projects? What is the difference between a screening and a preference decision? What is the time value of money and why does it matter in capital budgeting?
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What is the payback period and how is it calculated?

Beginner

Answer

The payback period is the time taken for a project's cumulative cash inflows to recover its initial investment. For even cash flows, payback = initial investment / annual cash inflow; for uneven flows, accumulate inflows until they equal the outlay. It's simple and focuses on liquidity/risk but ignores cash flows after payback and the time value of money.
Invest 100,000; inflow 25,000/yr -> payback = 100,000/25,000 = 4 years.
Real-world example A project recovering its cost in 3 years is preferred over one taking 5, under a payback rule.

Common follow-ups: What are payback's weaknesses? | How is it found for uneven cash flows?

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All 34 Capital Budgeting questions