The payback reciprocal is the payback period for an investment divided by 1. This reciprocal yields an approximation of the rate of return on an investment, though only under the following circumstances:
- Annual cash flows are uniformly even over the lifetime of the investment
- The cash flows from the project will continue forever
For example, a financial analyst is reviewing a possible investment of $50,000, which will generate positive cash flows of $10,000 per year. The payback period is 5 years, since cash flows of $50,000 will accumulate over the next five years. The payback reciprocal is 1 / 5 years, or 20%. The calculated internal rate of return using this reciprocal is 15% if the assumed cash flow period is 10 years, and reaches 20% only when the assumed cash flows cover a period of 30 years.
Since it is quite unlikely that cash flows will continue uninterrupted for a long ways into the future, it is more realistic to instead evaluate a project based on the net present value method or the internal rate of return.