After the initial purchase period (Year 0), the project generates $5 million in cash flows each year. From a capital budgeting perspective, this method is a much better method than a simple payback period. Thus, you should compare your year-end cash flow after making an investment. Once you have this information, you can use the following formula to calculate discounted payback period. In such situations, we will first take the difference between the year-end cash flow and the initial cost left to reduce. Next, we divide the number by the year-end cash flow in order to get the percentage of the time period left over after the project has been paid back.

As you can see, the required rate of return is lower for the second project. The next step is to subtract the number from 1 to obtain the percent of the year at which the project is paid back. Finally, we proceed to convert the percentage in months (e.g., 25% would be 3 months, etc.) and add the figure to the last year in order to arrive at the final discounted payback period number.

How Do I Calculate the Payback Period?

Additionally, it indicates the potential profitability of a certain business venture. For example, if a project indicates that the funds or initial investment will never be recovered by the discounted value of related cash inflows, the project would not be profitable at all. The company should therefore refrain from investing its funds in such project. The discounted payback period is a modified adjusting entries version of the payback period that accounts for the time value of money.

Discounted payback period is the time required to recover the initial investment in a given project after discounting future cash flows for the time value of money. Unlike simple payback, the discounted payback period considers today’s rupee worth more than the rupee received sometime in the future. The rest of the procedure is similar to the calculation of simple payback period except that we have to use the discounted cash flows as calculated above instead of nominal cash flows. Also, the cumulative cash flow is replaced by cumulative discounted cash flow. Use this calculator to determine the DPP ofa series of cash flows of up to 6 periods. Insert the initial investment (as a negativenumber since it is an outflow), the discount rate and the positive or negativecash flows for periods 1 to 6.

Company A invests in a new machine which expects to increase the contribution of $100,000 per year for five years. The payback period will help the company to use their fund more effective, it recommends to invest in a project which has the shortest payback period. However, before delving into the specifics of the discounted payback period, it is essential to first establish a clear understanding of the payback period itself. The shorter the payback period, the more likely the project will be accepted – all else being equal. I hope you guys got a reasonable understanding of what is payback period and discounted payback period. Discounted payback period process is a helpful metric to assess whether or not an investment is worth pursuing.

The discounted payback period acts as a financial criterion for evaluating investment projects by determining the time required to recoup the initial costs, considering the time value of money. This method is more accurate since it discounts future cash flows and presents a more realistic approach to estimating investment viability. Hence, the discounted payback period is an important practical tool in capital budgeting essential in deciding whether a particular line of investment should be pursued. Discounted payback method is a capital budgeting technique used to evaluate the profitability of a project based upon the inflows and outflows of cash.

• Following the figure you can draw a timeline of a project, put the amount of cashflows year-wise, and cumulative cash flows, and then find out the time using the payback period formula.
• It evaluates an investment option for a project with the following relevant cash flow details.
• The formula for the simple payback period and discounted variation are virtually identical.
• This method completely ignores accrual basic and the time value of money.

In this article, we will cover how to calculate discounted payback period. This will include the overview, key definition, example calculation, advantages and limitation of discounted payback period that you should know. The payback period indicates the time required for an investment to recoup its initial expenses through incoming cash without accounting for the time value of money. We can also employ the COUNTIF and VLOOKUP functions to calculate the discounted payback debit balance definition period.

Discounted Payback Period Calculator – Excel Model Template

Please note that if the discount rate increases, the distortion between the simple rate of return and discounted payback period increases. Let us take the 10% discount rate in the above example and calculate the discounted payback period. Payback period refers to the number of years it will take to pay back the initial investment. Discounted payback period refers to the number of years it takes for the present value of cash inflows to equal the initial investment. The payback period does not consider returns on investment beyond the break-even point and does not inherently account for the time value of money unless a discounted payback period is calculated.

The main difference is that the discounted payback period considers the time value of money, making it a more realistic approach. Uneven Cash Flow refers to a series of unequal payments made over a certain period, for instance a series of $5000, $8500, and $10000 made over 3 years. The most obvious way to calculate the discounted payback period in Excel is using the PV function to calculate the present value, then obtaining the payback period of the project. We can see that, how easy calculating the payback period is and figuring out the number of years we need to recover the initial investment. But the payback period has a major flaw that makes it traditional and most companies avoid calculating the payback period.

Once we’ve calculated the discounted cash flows for each period of the project, we can subtract them from the initial cost figure until we arrive at zero. The payback period focuses solely on how long it takes to recover the initial investment. In contrast, the Discounted Payback Period takes into account the time value of money by applying discounts to future cash flows.

Basic DPBP Method

This can be done using the present value function and a table in a spreadsheet program. To calculate payback period with irregular cash flows, you will need to calculate the present value of each cash flow. When using this metric, it’s important to keep in mind that a longer payback period doesn’t necessarily mean an investment is bad. You should also consider factors such as money’s time value and the overall risk of the investment. Option 1 has a discounted payback period of5.07 years, option 3 of 4.65 years while with option 2, a recovery of theinvestment is not achieved.

• It is an essential metric when evaluating the profitability and feasibility of any project.
• A shorter payback period generally signifies a lower risk and higher return potential.
• The discounted payback period takes this principle into account by applying a discount rate to future cash flows.
• Choosing investments with shorter discounted payback periods is essential for maximizing profitability and minimizing risks.

Example of the Discounted Payback Period Formula

This method completely ignores accrual basic and the time value of money. It is a useful way to work out how long it takes to get your capital back from the cash flows.It shows the number of years you will need to get that money back based on present returns. Each present value cash flow is calculated and then added together.The result is the discounted payback period or DPP. Our calculator uses the time value of money so you can see how well an investment is performing.

Contractor Calculators

There can be lots of strategies to use, so it can often be difficult to know where to start.

Among the various metrics used to evaluate the profitability of an investment, the payback period stands out as a straightforward and intuitive measure. The Excel payback formula is a valuable tool in calculating this metric, providing insights into how long it takes for an investment to generate returns equal to its initial cost. This article delves into the world of investment analysis, exploring the application, interpretation, and strategic use of the payback formula in Excel, alongside other essential financial metrics. Since it recognizes that money depreciates over time, the discounted payback period makes decisions for many investors and corporate houses.

However, the payback period method assumes all cash flows are worth the same, ignoring how inflation or investment returns can change their value over time. From above example, we can observe that the outcome with discounted payback method is less favorable than with simple payback method. Since discounting decreases the value of cash flows, the discounted payback period will always be longer than the simple payback period as long as the cash flows and discount rate are positive. The basic method of the discounted payback period is to take the future estimated cash flows of a project and discount them to their present value (using discounted cash flows).

The increase in inflation for consumer prices in the United States in April 2025, according to the Bureau of Labor Statistics. The core rate, which is adjusted to remove food and energy pricing, was 2.8%. Investors how to determine your grant applicant eligibility should consider the diminishing value of money when planning future investments. Discounted payback period serves as a way to tell whether an investment is worth undertaking.