{"id":762,"date":"2018-04-19T22:58:47","date_gmt":"2018-04-19T22:58:47","guid":{"rendered":"https:\/\/courses.lumenlearning.com\/wm-accountingformanagers\/?post_type=chapter&#038;p=762"},"modified":"2024-04-29T17:39:43","modified_gmt":"2024-04-29T17:39:43","slug":"the-payback-method","status":"publish","type":"chapter","link":"https:\/\/courses.lumenlearning.com\/wm-accountingformanagers\/chapter\/the-payback-method\/","title":{"raw":"The Payback Method","rendered":"The Payback Method"},"content":{"raw":"<div class=\"textbox learning-objectives\">\r\n<h3>Learning Objectives<\/h3>\r\n<ul>\r\n \t<li>Describe the pay-back method<\/li>\r\n<\/ul>\r\n<\/div>\r\nWhen we talk about the payback method, it is important to have a couple of pieces of information. First, we need the initial purchase price. We will also need to know what our net cash flow per year will be with this purchase. With this information, we can figure out how many years it will take to get our initial investment back.\r\n\r\nThis method, along with the net present value method and the internal rate of return method, all \u00a0use cash flows to determine decisions. Typical cash outflows include the initial investment in the equipment or project, including any installation costs or additional capital needed. Cash inflows may include the salvage value of the equipment, if any, increase in revenues and decreases in expenditures.\r\n\r\nLet\u2019s look at an example of the payback method.\r\n<div class=\"textbox examples\">\r\n<h3>Example<\/h3>\r\nWe purchase a $50,000 piece of machinery to make our widgets today. We will get $10,000 \u00a0in net cash flow per year from this piece of machinery. What is our payback period?\r\n<p style=\"text-align: center;\">5 years = $50,000\/$10,000<\/p>\r\nSo if we make this purchase, it will take us five years to get back our initial investment. Let\u2019s look at a couple of other options:\r\n<ul>\r\n \t<li><strong>Machine A:<\/strong>\u00a0Purchase price $25,000. Net annual cash flow $5,000<\/li>\r\n \t<li><strong>Machine B:<\/strong> Purchase price $36,000. Net annual cash flow $9,000<\/li>\r\n<\/ul>\r\nMachine A would pay back the initial investment in 5 years ($25,000\/$5,000 per year) while machine B would pay back the initial investment in 4 years ($36,000\/ $9,000 per year). So if we are just looking at the payback period, we would pick machine B, even though it costs <strong>more<\/strong> than machine A! The initial cash outlay is higher, but the money would be brought back into the company quicker. There may be other factors in play, but this method would encourage purchasing the more costly machine.\r\n\r\n<\/div>\r\n<div class=\"textbox tryit\">\r\n<h3>Practice Questions<\/h3>\r\nhttps:\/\/assess.lumenlearning.com\/practice\/62cc54a9-6de9-4b7e-b0c6-52c772679ea1\r\n<\/div>","rendered":"<div class=\"textbox learning-objectives\">\n<h3>Learning Objectives<\/h3>\n<ul>\n<li>Describe the pay-back method<\/li>\n<\/ul>\n<\/div>\n<p>When we talk about the payback method, it is important to have a couple of pieces of information. First, we need the initial purchase price. We will also need to know what our net cash flow per year will be with this purchase. With this information, we can figure out how many years it will take to get our initial investment back.<\/p>\n<p>This method, along with the net present value method and the internal rate of return method, all \u00a0use cash flows to determine decisions. Typical cash outflows include the initial investment in the equipment or project, including any installation costs or additional capital needed. Cash inflows may include the salvage value of the equipment, if any, increase in revenues and decreases in expenditures.<\/p>\n<p>Let\u2019s look at an example of the payback method.<\/p>\n<div class=\"textbox examples\">\n<h3>Example<\/h3>\n<p>We purchase a $50,000 piece of machinery to make our widgets today. We will get $10,000 \u00a0in net cash flow per year from this piece of machinery. What is our payback period?<\/p>\n<p style=\"text-align: center;\">5 years = $50,000\/$10,000<\/p>\n<p>So if we make this purchase, it will take us five years to get back our initial investment. Let\u2019s look at a couple of other options:<\/p>\n<ul>\n<li><strong>Machine A:<\/strong>\u00a0Purchase price $25,000. Net annual cash flow $5,000<\/li>\n<li><strong>Machine B:<\/strong> Purchase price $36,000. Net annual cash flow $9,000<\/li>\n<\/ul>\n<p>Machine A would pay back the initial investment in 5 years ($25,000\/$5,000 per year) while machine B would pay back the initial investment in 4 years ($36,000\/ $9,000 per year). So if we are just looking at the payback period, we would pick machine B, even though it costs <strong>more<\/strong> than machine A! The initial cash outlay is higher, but the money would be brought back into the company quicker. There may be other factors in play, but this method would encourage purchasing the more costly machine.<\/p>\n<\/div>\n<div class=\"textbox tryit\">\n<h3>Practice Questions<\/h3>\n<p>\t<iframe id=\"assessment_practice_62cc54a9-6de9-4b7e-b0c6-52c772679ea1\" class=\"resizable\" src=\"https:\/\/assess.lumenlearning.com\/practice\/62cc54a9-6de9-4b7e-b0c6-52c772679ea1?iframe_resize_id=assessment_practice_id_62cc54a9-6de9-4b7e-b0c6-52c772679ea1\" frameborder=\"0\" style=\"border:none;width:100%;height:100%;min-height:300px;\"><br \/>\n\t<\/iframe>\n<\/div>\n\n\t\t\t <section class=\"citations-section\" role=\"contentinfo\">\n\t\t\t <h3>Candela Citations<\/h3>\n\t\t\t\t\t <div>\n\t\t\t\t\t\t <div id=\"citation-list-762\">\n\t\t\t\t\t\t\t <div class=\"licensing\"><div class=\"license-attribution-dropdown-subheading\">CC licensed content, Original<\/div><ul class=\"citation-list\"><li>The Payback Method. <strong>Authored by<\/strong>: Freedom Learning Group. <strong>Provided by<\/strong>: Lumen Learning. <strong>License<\/strong>: <em><a target=\"_blank\" rel=\"license\" href=\"https:\/\/creativecommons.org\/licenses\/by\/4.0\/\">CC BY: Attribution<\/a><\/em><\/li><\/ul><\/div>\n\t\t\t\t\t\t <\/div>\n\t\t\t\t\t <\/div>\n\t\t\t <\/section>","protected":false},"author":62559,"menu_order":7,"template":"","meta":{"_candela_citation":"[{\"type\":\"original\",\"description\":\"The Payback Method\",\"author\":\"Freedom Learning Group\",\"organization\":\"Lumen Learning\",\"url\":\"\",\"project\":\"\",\"license\":\"cc-by\",\"license_terms\":\"\"}]","CANDELA_OUTCOMES_GUID":"306102d8-8943-4c52-867a-7d1f747fbe78, 7784e568-a4a7-4b67-9586-03b4c8ea2322","pb_show_title":"on","pb_short_title":"","pb_subtitle":"","pb_authors":[],"pb_section_license":""},"chapter-type":[],"contributor":[],"license":[],"class_list":["post-762","chapter","type-chapter","status-publish","hentry"],"part":114,"_links":{"self":[{"href":"https:\/\/courses.lumenlearning.com\/wm-accountingformanagers\/wp-json\/pressbooks\/v2\/chapters\/762","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/courses.lumenlearning.com\/wm-accountingformanagers\/wp-json\/pressbooks\/v2\/chapters"}],"about":[{"href":"https:\/\/courses.lumenlearning.com\/wm-accountingformanagers\/wp-json\/wp\/v2\/types\/chapter"}],"author":[{"embeddable":true,"href":"https:\/\/courses.lumenlearning.com\/wm-accountingformanagers\/wp-json\/wp\/v2\/users\/62559"}],"version-history":[{"count":10,"href":"https:\/\/courses.lumenlearning.com\/wm-accountingformanagers\/wp-json\/pressbooks\/v2\/chapters\/762\/revisions"}],"predecessor-version":[{"id":4184,"href":"https:\/\/courses.lumenlearning.com\/wm-accountingformanagers\/wp-json\/pressbooks\/v2\/chapters\/762\/revisions\/4184"}],"part":[{"href":"https:\/\/courses.lumenlearning.com\/wm-accountingformanagers\/wp-json\/pressbooks\/v2\/parts\/114"}],"metadata":[{"href":"https:\/\/courses.lumenlearning.com\/wm-accountingformanagers\/wp-json\/pressbooks\/v2\/chapters\/762\/metadata\/"}],"wp:attachment":[{"href":"https:\/\/courses.lumenlearning.com\/wm-accountingformanagers\/wp-json\/wp\/v2\/media?parent=762"}],"wp:term":[{"taxonomy":"chapter-type","embeddable":true,"href":"https:\/\/courses.lumenlearning.com\/wm-accountingformanagers\/wp-json\/pressbooks\/v2\/chapter-type?post=762"},{"taxonomy":"contributor","embeddable":true,"href":"https:\/\/courses.lumenlearning.com\/wm-accountingformanagers\/wp-json\/wp\/v2\/contributor?post=762"},{"taxonomy":"license","embeddable":true,"href":"https:\/\/courses.lumenlearning.com\/wm-accountingformanagers\/wp-json\/wp\/v2\/license?post=762"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}