The discounted payback period is an enhanced version of a simple payback period that considers the time value of money. The payback period is a metric typically used along with the Internal Rate of Return and Return on Investment in evaluating the profitability and feasibility of a particular project. However, it fails to consider the time value of money. For this reason, the discounted payback period was devised, and it now considers the time value of money by discounting the cash flows of the projects or investments. This article will try to refine your understanding of this topic and further explain the discounted payback period formula.

Understanding Discounted Payback Period

Let us dive deeper to understand the rationale of the discounted payback period. This metric is used to evaluate the profitability and timing of cash inflows of a particular project or investment. Future cash flows are discounted using company’s cost of capital. It is the period that a specific project takes to breakeven and recover the initial investment cost. A shorter payback period indicates good performance. If multiple projects are lined up, the shorter discounted payback period should likely be accepted.

Discounted Payback Period Formula

To calculate for the discounted payback period, the net cash flows for each year of the project have to be discounted to its present value. Once the discounted cash flows for each period are known, it has to be deducted from the initial investment cost until you reach zero. Here’s the discounted payback period formula which you could work on both Excel or calculator.

Discounted Cash Inflow = Actual Cash Inflow / (1 + i)n

Discounted Payback Period = Initial Cost of Investment – Cumulative Discounted Cash Inflow