Payback period

The payback period of a system is of concern when making decisions. Usually a decision involves a trade-off, where purchasing new equipment might have a higher upfront cost but allows for a lower ongoing cost, compared to the existing option that might have a higher ongoing cost.

The payback period can be calculated as the time it takes for the new option to become cheaper than the existing solution.

Example applications

There are several classic examples to make economic arguments for one system over another, especially when weighing up options at the acquisition stage. Some everyday examples include:

• purchase a phone outright with lower monthly fee, or receive a phone as part of a contract arrangement with higher monthly fee
• purchase solar panels for your home (high up-front cost, ongoing cost offset by production) or continue to pay a higher ongoing cost for electricity

Steps

• identify a situation of interest, such as comparing the purchase of new equipment to the running costs of existing equipment

• conduct a life-cycle costing (S11) of the options, and establish which are the upfront and which are the ongoing costs, including when the ongoing costs are payable - plot the costs over time (or other unit of interest, such as pages printed) for the options

• when plotted on an axis over time, there will be a point at which the two options cross - this is the payback period

Note that a payback period approach might also be used to discover the break-even point if the system is generating income.

Key concepts

• an explanation of when to use a payback period calculation
• an example that calculates the payback period
• advice to the student engineer on how to interpret a payback period calculation

A word to the wise

If you are conducting a payback period calculation extending out several years, you must take into consideration the range of likely values. For example, if electricity prices are a key part of your ongoing costs, you must consider the likely trends that might occur over that period of time (your variables are not constants!)

Core resources

A good guide for calculating the payback period is in the Victorian Government’s EREP Toolkit: Calculating payback periods

Similar tools…

High costs aren’t necessarily a problem, as long as the benefit can be clearly articulated as having value. A cost-benefit analysis could be useful to make the case about an investment. The Business Council of Australia’ guide describes when, why and how to use a cost-benefit analysis.

Further resources

The rules of thumb, methods and perspectives discussed in this toolkit are a selection of the available tools for undertaking an analysis of a system, design or process.

Chris actively encourages you to read wider, and incorporate other perspectives into your portfolio, such as developing models (physical and simulation) or choosing alternative tools. If you’re in any doubt, please use it as an opportunity to have a discussion with Chris or your tutor.

A great place to start further reading are the Systems Engineering textbooks listed on page 2.