Short definition: The payback period is the length of time required for an investment to generate enough cash flows to recover its initial cost.
Explanation: It is a simple and intuitive metric used to assess the risk and liquidity of an investment. A shorter payback period is generally preferred, as it indicates that the investment will recoup its costs sooner, reducing the risk of loss.
Example: If a project requires an initial investment of $50,000 and is expected to generate annual cash flows of $10,000, the payback period would be five years.
Additional information (optional): The payback period is a simple metric that does not take into account the time value of money or cash flows beyond the payback period. Therefore, it should not be used as the sole criterion for investment decisions.