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25.6 Determine and Evaluate Payback Periods and Discounted Payback

Payback in Practice​

Payback is often used to set a maximum acceptable time for investment recovery, especially when cash is tight or risk is high.

Example (Restaurant Expansion):

  • Initial investment: €350,000
  • Cash inflows: €90k, €100k, €110k, €120k, €130k
  • Payback: 3.4 years
  • If maximum acceptable payback = 4 years → Acceptable

Discounted Payback Example​

  • Discount rate: 8%
  • Discounted inflows:
    • Year 1: €90k / 1.08 = €83,333
    • Year 2: €100k / 1.08^2 = €85,733
    • Year 3: €110k / 1.08^3 = €87,032
    • Year 4: €120k / 1.08^4 = €88,073
  • Accumulate discounted inflows until initial investment recovered

Payback vs. NPV Decision​

  • If project meets payback but has negative NPV → Should be rejected (destroying value)
  • If project fails payback but has positive NPV → Consider strategic importance and risk tolerance

Using Payback for Maintenance Projects​

Payback is useful for replacement projects where cash flows are cost savings. Example: Replace old equipment to save energy costs.

Luxembourg Compliance Note​

Luxembourg SMEs often face high fixed costs and limited financing, making payback an important liquidity metric. However, positive NPV should be the primary decision criterion.

Think It Through​

Why might a project with a short payback still be a bad investment? How can payback be combined with DCF metrics for better decisions?