Year            Annual cash inflow        cumulated annual cash inflow.

1                 2000                              2000

2                 4000                              6000

3                 4000                              10000

4                 5000                              15000

Up to 3rd year the initial investment of Rs. 12000 is not recovered, rather only Rs.10000 is recovered. But the total cash inflow for the 4 years is 15000 ie. Rs.3000 more than the cost of the project. Thus the time required to recover Rs. 2000 will be 2000  = 0.4years.  Here the payback period 3.4 years.

5000

Advantages of payback period.

1. Simple to understand and easy to calculate.
2. As the project with a short payback period is preferred the chance of obsolescence is reduced.
3. A firm which has shortage of funds finds this method very useful.
4. This method costs less as it requires only very little effort for its computation.

Disadvantages

1. This method cannot take into consideration the cash inflows beyond the pay back period.
2. It does not take into consideration the time value of money.
3. It gives over emphasis for liquidity