The payback period, return period or average maturation period (also called in English, payback period), is one of the so-called static selection methods).

There are various subperiods that form the average maturation period. If we consider an industrial type company, we can decompose the average maturation period into 5 subperiods:

This tool is very useful when you want to make an investment with high uncertainty and in this way we have an idea of ​​the time that will have to pass to recover the money that has been invested.

However, payback, like other static selection methods, does not take into account either the present value of future cash flows or the cash flow of recent periods. Therefore, although the analysis is simpler, it is not as complete as one carried out with a dynamic selection method.

If in an investment an amount of 400 euros is initially allocated from which profitability is desired, this figure is placed under a negative sign at the beginning of a segment that graphically represents the development of the investment, which in this case lasts 6 years. This segment must be divided into as many parts as the net cash flows support the investment during the periods in which money is returned to the company. That is, if this specific investment returns us 100 euros annually, we place them with a positive sign above each net cash flow. In total, there are 6 net cash flows during the investment. The pay-back is 4 years, that is, in 4 years the initial investment, 400 euros, is returned. The profits obtained from the investment, 200 euros, are not taken into account by the pay-back. For this calculation there is a formula that is as follows:

Pay-back = Initial disbursement/FNCj (net cash flow of year j).

The formula is only valid if the FNC is the same for each year.

It has drawbacks:

The way to calculate it is by means of the accumulated sum of the cash flows, until it equals the initial investment.

Choose a project based on the payback period assessment criterion:.

The project that recovers the initial investment first is Project A, therefore, based on the recovery period criterion, this would be the selected project. However, if we had used the NPV our choice would have been different (we would have chosen Project C). This happens due to the considerations we make in the following section.

When we use this criterion to value an investment we must be aware that it can lead us to choose projects that are not always the most profitable. Mainly for two reasons: