Discounted vs plain payback
Plain payback counts cash until the outlay is back, with no charge for waiting. Discounted payback does the same count on cash brought to today first. A $60,000 machine returning $18,000 a year pays back in 3.33 years plain and 4.26 years at 10 percent.
| Plain payback | Discounted payback | |
|---|---|---|
| What is added up | Nominal cash, year by year. | Present values of those cash flows, then the same count. |
| \$60,000 machine, \$18,000 a year | 3.33 years. By the end of year 4 the project has collected $72,000. | 4.26 years at 10 percent. The five discounted receipts add to $68,234.16. |
| What happens after payback | Ignored. Year 5 of $18,000 does not show. | Still ignored. Discounting does not keep counting after the outlay is back. |
| Two projects, \$25,000 a year | Both pay back in 2.4 years, one then stops, the other runs three more years. | Still a screen, not a ranking. NPV is the ranking tool. |
| What it is for | A fast screen for how long cash is tied up. | The same screen, with waiting no longer free. |
| What it is not | A value. Same payback, twice the cash, is a standard trap. | NPV. It still throws away the tail after the outlay is recovered. |
On this page
The same machine, two clocks
A $60,000 machine returning $18,000 a year pays back in 3.33 years if a dollar in year 4 is treated as a dollar today. Discount each $18,000 at 10 percent: $16,363.64, $14,876.03, $13,523.67, $12,294.24, $11,176.58. Discounted payback is 4.26 years, and the five receipts are worth $68,234.16 in today's money against the $60,000 cost.
How the payback period works is the long form. How NPV and IRR work is the page that keeps counting after the outlay is back.
Discounting does not fix the ranking problem
Two projects can each cost $60,000, each return $25,000 a year, and each pay back in 2.4 years. One then stops. The other collects another $75,000 that payback never sees. Discounting the receipts changes the clock. It does not start counting the tail.
The payback period calculator is the count. The NPV calculator is the ranking. This is educational material, not financial advice.
Worked examples
A \$60,000 machine returning \$18,000 a year
A machine costs $60,000 up front and is expected to bring in $18,000 of net cash a year for five years. How long before it has paid for itself?
- Run the cash total forward: after year 1, after year 2, after year 3. The cost is not covered yet.
- Year 4 opens with still to recover.
- That year brings in $18,000, so the shortfall clears of the way through it.
- Payback is years, which is 3 years and 4 months.
The machine pays for itself in 3.33 years. Payback lands a third of the way into year 4, by the end of which the project has collected $72,000 against the $60,000 it cost. What is left after the payback date is a further year and eight months of cash, and that is the part a project is bought for. The payback figure says nothing about it.
The same machine with the waiting priced in
Plain payback counts a dollar in year 4 as equal to a dollar today. Charge 10 percent a year for the waiting first, then ask the same question of the same $60,000 machine.
- Discount each year's $18,000 back to today: , , , , .
- Run the total on those figures: , then , then , then by the end of year 4, still short of .
- Year 5 opens with left to recover, against $11,176.58 arriving that year.
- of the year, so payback is years.
Discounted payback is 4.26 years against 3.33 years for the same machine, nearly a year later, and not one of the project's cash flows changed. All five years are worth $68,234.16 in today's money against the $60,000 the machine cost, so the project still clears its outlay, but most of its life now goes on simply getting the money back. Plain payback treats waiting as free, and over a long project that is a large thing to treat as free.
Two projects, the same payback, very different value
Two projects each cost $60,000 and each return $25,000 of cash a year. Project A wears out at the end of year 3. Project B runs for six years. Payback scores them identically. Should you?
- Both collect in year 1 and by the end of year 2, so both are still short.
- Both clear that in year 3: of the year, so payback is years for each.
- By the end of year 3 each has taken in $75,000, and that is where Project A stops.
- Project B collects another $75,000 across years 4, 5 and 6. The payback count ended at 2.4 years, so none of it registers.
Both pay back in 2.4 years, and by the end of year 3 both have collected $75,000 against the $60,000 they cost. Project B then earns a further $75,000 that Project A never sees. Same score, and B collects twice the cash. Take the $60,000 cost off each and B's gain is six times A's, not twice it. Price the waiting in as well and the gap is wider still. Payback is not measuring value, so it cannot rank by value.
Common questions
Is discounted payback enough to choose a project?
No. It is better than plain payback in one way: it charges for waiting, which is why the same machine moves from 3.33 years to 4.26. It still stops once the $60,000 is back, so a long tail of cash after that date still does not show.
Should payback use cash or profit?
Cash. The $18,000 on this sheet is net cash, not an accounting profit line. Depreciation reduces profit without money leaving the bank, so a payback from profit shows a longer wait than the real one.
Keep reading
This page is educational material, not financial advice. The figures come from the formula shown and assume the inputs you enter hold for the whole term. Your own rate, fees, taxes and timing will differ, so treat the output as arithmetic to check a decision against, not as a recommendation.