The calculation of the payback period is relatively straightforward, especially for projects that generate consistent annual cash flows. The basic formula is:
Payback Period = Initial Investment / Annual Cash Inflows
For example, if a company invests $100,000 in a project that generates $25,000 annually, the payback period would be:
Payback Period = $100,000 / $25,000 = 4 years
However, for projects with irregular cash flows, the calculation is more complex and involves summing the cash flows until the initial investment is recovered.