We calculate the payback period of capital investments

The investment project provides for the investment of significant amounts of financial resources. The initial task of investors is to determine the most attractive object for cash injections. Undoubtedly, they will have an enterprise that has a minimum payback period. But this practice is not always expedient 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

For the evaluation of investment risks, the payback period of investments is calculated. This indicator of evaluation is the period of time for which the invested funds will fully return and begin to make a profit. There are three types of project payback:

• simple - from the first step to the return of all investments;
• for the period of operation - does not include the investment phase;
• The discounted payback period is the achievement of the moment of return of the 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 initial costs to the average annual income, that is, in order 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 the cash flows beyond the payback limits, but allows you to draw conclusions about the liquidity and the degree of project risk.

Discounting

If incomes come unevenly, then the payback period is calculated taking into account the different cost of money in time. This method calculates the time period necessary to return the advanced capital with the planned rate of return. Discounting is the calculation of the present value of money that will be received in the future.

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

• Weighted average cost of capital;
• based on the safe investment rate (adjusted for and without risk factors );
• based on the effective interest rate on loan capital;
• adjusted for risk and cost of debt;
• on the basis of the norm of profitability (internal);
• the method of peer review.

The discounted payback period is considered according to the formula in which the discount factor, the number of periods, the amount of initial investments, and the average annual amount of the project's revenues take part.

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

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