Payback period is the first formal and basic capital budgeting technique used to assess the viability of the project. It is defined as the time period required for the investment’s returns to cover its cost. Payback period is easy to apply and easy to understand technique; therefore, widely used by investors.
For example, an investment of $5000 which returns $1000 per year will have a five year payback period. Shorter payback periods are more desirable for the investors than longer payback periods.
It is considered as a method of analysis with serious limitations and qualifications for its use. Because it does not properly account for the time value of money, risk and other important considerations such as opportunity cost.