[ Music ] >> First we're going to talk about payback period, one of the analyses or techniques used to analyze capital investments. The definition of payback period is the time period required to recover the cost of capital investment from the net annual cash flows. So back to Hogarth's example, where in year zero, or at the beginning of this project's life, we have an outflow of $23,000 to purchase the machine. In year's 1, 2, 3 and 4 we have cash savings from this machine, so let's calculate the payback period for this investment. So looking at our example, we know that the initial outflow is $23,000, and the payback period is telling us how long in terms of number of years it takes to recover that initial outflow. Well, in year one we recover $10,000 of it, meaning that at the end of year one we have yet to recover $13,000 of that initial investment. At the end of year two we have cost savings or cash inflow of $8,000, meaning that at the end of year two we've yet to recover $5,000 of the initial investment. And finally at the end of year three we have cash savings or an inflow of $6,000, and that means that we have recovered all $23,000 of the initial investment. Now, I've treated it this way because of the given information in the case that said that all cash savings and cash flows occur at the end of the year. If this were not the case, if it were indeed the case that cash was collected regularly throughout the year, we could see that only part of year three is necessary to recover the rest of the $23,000 investment. In essence, if we assume that the cash is collected evenly throughout the year, then really 5,000 out of the $6,000 of cash savings that we have in year three takes us down to a full recovery amount. That means that 5/6th of the year, or .83 of the year, is required to recover the remainder of the $23,000. So in essence we have year one, year two, and .83 of year three that leads to the full recovery of the initial outflow of $23,000. So the payback period under this alternative assumption is 2.83 years. Now let's talk about some advantages and disadvantages of using the payback period measure for capital investment decisions. First off, the payback period is quite simple; as you saw via this calculation it's just a matter of counting up the years before the initial outflow is recovered. Another advantage is that it's an indicator of cash availability; managers know when they will recover that initial outflow and when they'll have that cash for future periods. And finally, it's a surface level indicator of risk, and this is very important to understand when try8ing to compare multiple opportunities or investments. Knowing that an investment returns it's cash earlier than others runs-- offsets the risk of perhaps a project becoming obsolete, especially in its later years. A key disadvantage of the payback period however, is that it ignores other aspects of the investment, but what happens after payback is completed, after that initial outflow is completely recovered, is ignored in this measure.