The payback period is the calculation of the time period in which an investor’s initial investment would be recouped. It is calculated as the time period in which project inflows match project outflows investment. The payback period is calculated in two ways i.e.
1: (Undiscounted) Payback Period:
It is based on undiscounted cash flows. It is easy to calculate but ignores the time value of money. Based on data used above the payback period can be calculated as follows:
From the data above, we can see that project investment is being recovered in the 4th year. So the formula for the payback period would be:
= 3 years +recoverable investment at the end of year 3
net cash inflow for year 4
= 3 + 400,000
1,200,000
= 3.33 years
2: Discounted Payback Period:
Discounted payback uses discounted cash flows for the purpose of calculating the payback period. Everything would be the same as above except for the use of discounted cash flows:
From the data above, we can see that project investment is being recovered in the 4th year. So the formula for the payback period would be:
= 3 years +recoverable investment at the end of year 3
net cash inflow for year 4
= 3 + 400,000
1,200,000
= 3.33 years

Discounted Payback Period:
Discounted payback uses discounted cash flows for the purpose of calculating the payback period. Everything would be the same as above except for the use of discounted cash flows:
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