3.8 Payback period and average rate of return

PBP - payback period. Time it takes to pay for investment using gains from investment ARR - average annual profit expressed in percentage of initial investment

PAYBACK PERIOD $\frac{\text{cost of investment}}{\text{contribution per month}}$ Use cumulative net cash flow

Advantages of the payback period

• easiest and fastest method to calculate investment appraisal
• Easy to understand
• help businesses survive recessions
• Good for fast changing industries, new products and trends become outdated quickly
• aids in decision making

Disadvantages

• doesn’t account for deflation
• not good for long term projects with long payback periods
• useful life of investment is not considered by the payback period
• PBP doesn’t tell you info about the profitability of an investment long term

do 3.8 dynamic quiz in ARR

• the higher the ARR, the more money per annum you get out of your investment. High ARR means happy managers
• Also kind of sad, high ARR means high interest rates (because you need loan to pay for investment)