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Finance · level 1

Payback and its reciprocal

One division tells you the payback, and flipping it gives the crude annual return. Interviewers use it as a screen before any discounting happens.

Theory: Time Value of Money

Worked example: Investment $11M, annual cash flow $2.5M. Payback in years?

investment$11M
annual cash$2.5M
payback4.4 yrs

Step by step

  1. 1

    Investment / annual cash

    $11M / $2.5M = 4.4 years

  2. 2

    Implied return

    1 / 4.4 = 22.7% a year

    Payback and a simple annual yield are reciprocals.

  3. 3

    Caveat

    Payback ignores everything after the cut-off and ignores the time value of money.

Investment $11M, annual cash flow $2.5M. Payback in years? = 4.4

The theory behind it

Intuition

Payback answers a risk question, not a value question: how long is capital exposed.

Common pitfalls

  • ×Using payback to rank projects — it ignores everything after the payback date.
  • ×Forgetting to discount when the horizon is long.

In the interview

Capex and network-build rounds where the client cares about years, not NPV.