when deciding on any project to embark on a company or investor wants to know when their investment will pay off meaning when the cash flows generated from the project will cover the cost of the project 
this is particularly useful because companies and investors usually have to choose between more than one project or investment so being able to determine when certain projects will pay back compared to others makes the decision easier the basic method of the discounted payback period is taking the future estimated cash flows of a project and discounting them to the present value this is compared to the initial outlay of capital for the investment the period of time that a project or investment takes for the present value of future cash flows to equal the initial cost provides an indication of when the project or investment will break even the point after that is when cash flows will be above the initial cost the shorter a discounted payback period is means the sooner a project or investment will generate cash flows to cover the initial cost a general rule to consider when using the discounted payback period is to accept projects that have a payback period that is shorter than the target timeframe a company can compare its required break even date for a project to the point at which the project will break even according to the discounted cash flows used in the discounted payback period analysis to approve or reject the project calculating the discounted payback periodto begin the periodic cash flows of a project must be estimated and shown by each period in a table or spreadsheet these cash flows are then reduced by their present value factor to reflect the discounting process this can be done using the present value function and a table in a spreadsheet program next assuming the project starts with a large cash outflow or investment to begin the project the future discounted cash inflows are netted against the initial investment outflow the discounted payback period process is applied to each additional period s cash inflow to find the point at which the inflows equal the outflows at this point the project s initial cost has been paid off with the payback period being reduced to zero the inflation rate for consumer prices in the united states according to the bureau of labor statistics in june 2024 1 investors should consider the diminishing value of money when planning future investments payback period vs discounted payback periodthe payback period is the amount of time for a project to break even in cash collections using nominal dollars alternatively the discounted payback period reflects the amount of time necessary to break even in a project based not only on what cash flows occur but when they occur and the prevailing rate of return in the market these two calculations although similar may not return the same result due to the discounting of cash flows for example projects with higher cash flows toward the end of a project s life will experience greater discounting due to compound interest for this reason the payback period may return a positive figure while the discounted payback period returns a negative figure example of the discounted payback periodassume that company a has a project requiring an initial cash outlay of 3 000 the project is expected to return 1 000 each period for the next five periods and the appropriate discount rate is 4 the discounted payback period calculation begins with the 3 000 cash outlay in the starting period the first period will experience a 1 000 cash inflow using the present value discount calculation this figure is 1 000 1 04 961 54 thus after the first period the project still requires 3 000 961 54 2 038 46 to break even after the discounted cash flows of 1 000 1 04 2 924 56 in period two and 1 000 1 04 3 889 00 in period three the net project balance is 3 000 961 54 924 56 889 00 224 90 therefore after receipt of the fourth payment which is discounted to 854 80 the project will have a positive balance of 629 90 therefore the discounted payback period is sometime during the fourth period 