We calculate the payback period of capital investments

The investment project involves the investment of significant amounts of financial resources. The initial task of investors is to determine the most attractive object for cash injections. Undoubtedly, it will be an enterprise with a minimum payback period. But this practice is not always advisable in the field of commercial real estate. In addition, take into account:

• net and discounted income;
• internal rate of return;
• profitability index.

The essence of calculating the payback period

To assess investment risks, the payback period of investments is calculated. This measurement indicator is a period of time for which the invested funds will fully return and begin to make a profit. Three types of project payback are calculated:

• simple - from the first step to the return of all investments;
• for the period of operation - does not include the investment phase;
• discounted payback period - reaching the time of return on invested money, taking into account the discount rate.

The first and second are used if the parts of the advanced capital are evenly distributed over time. These methods consider the payback period as the ratio of the initial costs to the average annual income, that is, to find the payback period of the project, it is necessary to divide the initial investments by the average annual amount of income from the project.

The simple calculation method does not take into account cash flows beyond the payback, but allows conclusions to be drawn about the liquidity and risk level of the project.

Discounting

If incomes do not flow evenly, then the payback period is calculated taking into account the different cost of money over time. This method calculates the period of time needed to return the advanced capital with the planned rate of return. Discounting is the calculation of the present value of the money that will be received in the future.

To obtain reliable results, it is necessary to have information about the planned income, expenses, investments, the value of liabilities and the discount rate. The latter is determined in several ways:

• at the weighted average cost of capital;
• based on the rate on safe investments (adjusted for various risk factors and without it);
• based on the effective interest rate on loan capital;
• adjusted for risk and debt value;
• based on the rate of return (internal);
• expert assessment method.

The discounted payback period is calculated according to the formula in which the discount factor, the number of periods, the amount of initial investments, as well as the average annual income from the implementation of the project “take part”.

The obtained value allows us to evaluate the efficiency of capital investment and the level of investment risks.

The payback period criterion allows you to cut off the most dubious and risky proposals at the initial stage. Upon further consideration of investment objects, it is recommended to use it in combination with other methods of determining attractiveness.