Question

A manufacturer plans to open a new plant. The new plant will cost $4,000,000 to build and make ready for production. Company management believes that the plant will produce a net profit of $130,000 in the first year and that profit will increase 5% per year until year 7 at which point profit will remain constant for the remainder of the plant’s useful life. Determine the payback period for the plant. Do not consider the effect of interest. Express your answer in years to the nearest whole year.

Answer 1

Intial Investment = 4,000,000

Profit in 1st year = 130,000

Profit increases by 5% each year till 7th Year.

After that, profit remains constant for remainder life.

Payback Table:

Net Invested Cash is calculated by adding the profit of that year to previous year investment cash.

Year	Profit	Net Invested Cash
0		(4,000,000.00)
1	130,000.00	(3,870,000.00)
2	136,500.00	(3,733,500.00)
3	143,325.00	(3,590,175.00)
4	150,491.25	(3,439,683.75)
5	158,015.81	(3,281,667.94)
6	165,916.60	(3,115,751.33)
7	174,212.43	(2,941,538.90)
8	174,212.43	(2,767,326.47)
9	174,212.43	(2,593,114.03)
10	174,212.43	(2,418,901.60)
11	174,212.43	(2,244,689.17)
12	174,212.43	(2,070,476.73)
13	174,212.43	(1,896,264.30)
14	174,212.43	(1,722,051.87)
15	174,212.43	(1,547,839.43)
16	174,212.43	(1,373,627.00)
17	174,212.43	(1,199,414.57)
18	174,212.43	(1,025,202.14)
19	174,212.43	(850,989.70)
20	174,212.43	(676,777.27)
21	174,212.43	(502,564.84)
22	174,212.43	(328,352.40)
23	174,212.43	(154,139.97)
24	174,212.43	20,072.46

The value of net invested cash becomes positive in the 24th year.

Hence, all the years profit is able to set off th initial investment in 24th year without considering the effect of interest.

Payback Period = 24 years