The payback on an investment shows how long it takes for the investment to pay for itself. Calculating the payback requires knowing the cost of the investment and the annual cash flows from it. The calculation provides investors with an approximate date when the investment's cash in-flows will pay for its cash out-flows. Payback is useful because it gives investors an idea of when to expect to start making money on an investment.
Determine the cost of the project. For example, Firm A wants to install new manufacturing machines to increase productivity. The cost of the machines is $5,000.
Determine the estimated annual cash flows. In our example, Firm A estimates the new machines will increase production by $800 a year.
Divide the cost of the project by the estimated annual cash flows. In our example, $5,000 divided by $800 a year equals 6.25 years until the investment is paid back.