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Advantages and disadvantages of payback period method
The net cash flow brought by investment accumulates to the required number of years equal to the original investment, that is, the number of years required to recover the original investment, which is called the investment payback period. So what are the classifications of payback period? What are the advantages and disadvantages of payback period?

What are the classifications of payback period?

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The payback period can be divided into static payback period, dynamic payback period and differential payback period.

1, static payback period

Static payback period refers to the time required to recover all the investment from the net income of the project without considering the time value of funds. The payback period of investment can be calculated from the first year of project construction or the first year of project production, but attention should be paid to it.

(1) calculation formula

The static payback period can be calculated according to the cash flow statement, and the calculation is divided into two situations:

1) After the project is completed and put into production, the annual net income remains unchanged, so the calculation formula of static investment payback period is as follows:

pt=k/a .

2) If the annual net income after the project is completed and put into production is different, the static investment payback period can be obtained according to the accumulated net cash flow, that is, the year when the accumulated net cash flow in the cash flow statement is from negative to positive.

Its calculation formula is:

Absolute value of accumulated net cash flow in the previous year/positive value of net cash flow in the current year+year when accumulated net cash flow starts to show positive value-1=Pt.

(2) Evaluation criteria

Compare the determined benchmark payback period (Pc) with the calculated static payback period (Pt):

L) If Pt is less than or equal to Pc, which means that the project investment can be recovered within the specified time, then the scheme can be considered for acceptance;

2) If Pt is greater than Pc, the scheme is not feasible.

The payback period is 1.png.

2. Dynamic payback period

Dynamic payback period is the payback period calculated by converting the annual net cash flow of investment projects into present value according to the benchmark rate of return, which is the fundamental difference between it and static payback period. Dynamic payback period is the year when the cumulative present value of net cash flow is equal to zero.

The calculated dynamic payback period should also be compared with the industry standard dynamic payback period or the industry average dynamic payback period. If it is lower than the corresponding standard, the project is considered feasible.

Investors are generally concerned about the speed of investment recovery. In order to reduce the investment risk, they all hope that the sooner the investment is recovered, the better. Dynamic payback period is a commonly used economic evaluation index. The dynamic payback period is more in line with the actual situation, which makes up for the lack of considering the time value of funds in the static payback period.

(l) calculation formula.

In practical application, the calculation of dynamic payback period of investment is based on the cash flow statement of the project, and is calculated according to the following approximate formula:

The absolute value of the present value of accumulated net cash flow in the previous year/the present value of accumulated net cash flow in the current year is positive+(the year when the present value of accumulated net cash flow is positive-1) = p t.

(2) evaluation criteria.

1) when P t is less than or equal to PC (benchmark investment payback period), it shows that the project (or scheme) can recover its investment within the specified time, which is feasible;

2)P't is greater than Pc, and the project (or scheme) is not feasible and should be rejected.

The payback period of static analysis calculation is short, and the economic effect may be considered acceptable by decision makers. However, if the time factor is considered, the dynamic payback period calculated by discount method is longer than the static payback period calculated by traditional method, so this scheme may not be accepted.

3. Payback period of differential investment

The payback period of differentiated investment refers to the cost saved every year and the years needed to increase investment are recovered year by year.

The expression is △Pt=K2-K 1/C 1-C2.

The comparison scheme must meet the same demand without interest.

It means that the scheme with a large investment amount saves less operating costs than the scheme with a small investment amount and no interest, thus recovering the time required for the differential investment.

When several schemes can meet the same demand, the difference investment method is used for comparison, but the best scheme is required to be selected among these schemes. Provided that each scheme meets similar requirements.

What are the advantages and disadvantages of payback period method?

The advantages of payback period method are easy to understand and simple to calculate, and investment risks are considered to some extent.

However, the payback period also has some fatal shortcomings:

First of all, it does not consider the time value of funds, and gives equal weight to cash flows in each period;

Second, only consider the contribution of cash flow before the payback period to investment income, but ignore the cash flow after the payback period;

Thirdly, it is subjective to determine the standard period of investment payback period.

The above is the whole content of the payback period. I hope the above contents will be helpful to everyone's investment transactions. Thanks for your support and encouragement.