How is the Payback Period calculated?

The term payback period refers to the amount of time it takes to recover the cost of an investment. Simply put, it is the length of time an investment reaches a break-even point. People and corporations invest money primarily to be paid back, which is why the payback period is so critical. In essence, the shorter the payback period of an investment, the more appealing it becomes. The payback period can be calculated for anyone by dividing the initial investment by the average cash flows.

Payback Period = Cost of Investment/Average Annual Cash Flow