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Payback Period Target: two years after start of operations

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:

Equity Balances in Baseline Scenario
Year of Operation Equity
Initial capital 800,000
Y1 408,500
Y2 260,300
Y3 808,100
Y4 1’690,000
At the end of Year 3 equity is 808,300 indicating that the capital has been fully recovered, thus, payback period is three years. m5 PB baseline The graphic method confirms that at the end of Year 3 equity equals initial equity, 800,000, where the blue line crosses the red line.
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.

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