Payback Period

Posted on March 16, 2009 by

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One of the several financial selection techniques that may be used to compare potential projects in order to estimate which would be the most financially beneficial is Payback Period. Selecting among projects takes place at the program or portfolio level where the organization decides which projects are worth the investment. The potential return on investment may be only one of several criteria used for selecting among projects, however. Project selection methods were considered a tool of the 3rd edition PMBOK’s Develop Project Charter process, but it is not mentioned in the 4th edition. Payback Period is not as informative as other financial selection techniques such as Internal Rate of Return and Net Present Value. But it is a quick, simple method for comparing potential projects that project managers should understand.

Payback Period is simply the amount of time it will take for the project to break even with its initial investment. The faster one can get their money back, the better, so the project with the shortest Payback Period is preferred. For example, if project A has a Payback Period of 1 year and project B has a Payback Period of 2 years, we would prefer to select project A.

Before comparing among projects, the Payback Period will have to be calculated. It is important that accurate data be obtained to make these estimations. For example, if project C will cost $75, and the first 3 months will provide no returns, but after that the project will bring $25 per month, what is the Payback Period? The Payback Period would be 6 months. The first three months total $0, month 4 totals $25, month 5 totals $50, and month 6 totals $75. At month 6, we have gotten back the $75 that we invested in the project.