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Payback period

Value can be different things to different people. The payback period is exactly what it sounds like. How long will it take before we recoup the money spent on a project before we realize its value? Typically, the payback period determines how quickly the money will be paid back over time, but it doesn't have to be. On some projects, spending money to improve a process or product may cost money to complete, but that money won't be returned. The value is a leaner process flow, better quality management, and so on, which can help the organization save or gain money in the future.

For exam purposes, the majority of questions will be based on the premise of how much the project will cost and how quickly the invested money will be paid back before the organization begins to make a profit. Some payback periods are faster than others, which is the best-case scenario for organizations because today's money isn't going to be worth the same tomorrow. The faster the payback period, the faster the organization profits.

Payback period is the least precise of the selection techniques, and in some cases longer-term projects take more time to recoup costs but may end up with the higher ROI in the long run. That is why the payback period is combined with other methods. Other methods help organizations have a well-rounded assessment.

Think about the biggest blockbuster movie you have seen recently that made millions on the opening weekend. It may have taken two years and $8,000,000 to get to opening night, but the studio made $27,000,000 opening weekend and continues to make money in theaters. The payback period was fast and profitable. A cult classic may take years to become popular and take a longer time to recoup the initial investment. Both are profitable, but the blockbuster's payback period is much better. We can't always know though. There are studios that make a huge flop and never get their original investment back. This is typically why organizations gather as much information as they can in the business case in an attempt to make educated guesses based on historical information and expert judgment.

Always choose the fastest payback period if it is the only variable in the question. For example, project A has a payback period of five years and project B has a payback period of three years. Which project do you select? Project B. When you review the economic models in the following section, you'll see why the payback period on its own is the least influential selection method when combined with other methods.

Remember, the payback period is the least precise project-selection method and would need to be combined with other methods.