It defines the period by which equity of an ongoing company to be equal to original equity when capital was first invested in the firm and indicates how long it will take to the company to recover their invested capital. Investors are interested in knowing: how long will it take for the company to pay itself back?
Shorter payback periods are preferred over longer payback periods (all other things being equal), as investors consider shorter periods as being less risky. The quicker they recover their money the better!
In the baseline case scenario equity balances at the end of each fiscal period, as shown in the balance sheets, are:
|Year of Operation||Equity|
Conclusion on Payback in the Baseline Case
The payback happens at the end of Year 3 thus the investment project is not accepted to be implemented as it is beyond the two years payback target. The investors and lenders find that the investment is too risky and may lose money if they proceed to carry out the investment. Investors and lenders would be exposed to risks of higher taxes, lower sales and higher costs. Possibly even political risks as the country where the investment would take place is politically unstable.
Subscribe today and learn the fundamentals
It seems you don't have access to the exclusive content of The Course.
In order to gain access to the content of The Course you will have to register with EntreprenAble. Membership with EntreprenAble will also give you access to our interactive Business Game and Accounting Simulations.
Subscribe today and get:
- Unlimited website access to The Course
- Optimized view for Desktop, Tablet and Mobile devices
- Free 7-day, no obligation trial - normally £15
Test-drive the system for free