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Payback Period

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In corporate finance, the payback period is a simple measure of the time it takes to recover capital spent on an investment. For example, if a $100,000 machine reduces factory production costs by $25,000 a month, the payback period for investing in the machine is four months. As a basic measure of investment attractiveness, the payback period tends to be most compelling when the period is relatively short. A payback rule is a policy to make a capital expenditure only when the payback period is less than or equal to some period, such as one year. In the major corporation, more sophisticated measures are often used in lieu of the payback period. Net present value (NPV) is recognized as a superior financial measure to the payback period analysis because the payback period does not consider the time value of money. Another alternative to the payback period is the internal rate of return, or IRR.



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