Explain Payback period.

The payback period is a financial metric used to evaluate the time it takes for an investment to recoup its initial cost through the cash flows it generates. It represents the length of time required for the cumulative cash inflows from the investment to equal the initial investment amount.

In simpler terms, the payback period answers the question: "How long will it take to recover the money invested in a project or investment?"

The calculation of the payback period involves dividing the initial investment cost by the average annual cash inflow generated by the investment:

[ \text{Payback period} = \frac{\text{Initial investment cost}}{\text{Average annual cash inflow}} ]

A shorter payback period indicates that the investment recovers its initial cost more quickly, while a longer payback period suggests a slower recovery.

The payback period is commonly used as a quick and straightforward method for assessing the risk and return of investment projects, particularly for small-scale investments or those with relatively stable cash flows. However, it does not account for the time value of money or consider cash flows beyond the payback period, making it less precise for evaluating the overall profitability or efficiency of long-term investments.