1 divided by the payback period (i.e., the reciprocal of the payback time). This often gives a quick, accurate estimate of the Internal Rate of Return (IRR) on an investment when the project life is more than twice the payback period and the cash inflows are uniform during every period. For example, XYZ Company is contemplating three projects, each of which would require an initial investment of $10,000, and each of which is expected to generate a cash inflow of $2000 per year. The payback period is five years ($10,000/ $2000), and the payback reciprocal is 1/5, or 20%. The table of the present value of an annuity of $1 shows that the factor of 5.00 applies to the following useful lives and internal rates of return:
It can be observed that the payback reciprocal is 20% as compared with the IRR of 18% when the life is 15 years, and 20% as compared with the IRR of 19% when the life is 20 years. This shows that the payback reciprocal gives a reasonable approximation of the IRR if the useful life of the project is at least twice the payback period.