Question

An investment project will cost the firm $200,000 now. The additional cash flows earned as a result of the investment are $30,000 in the first year; $50,000 in the second year; $75,000 in the third year; $90,000 in the fourth year; and $120,000 in the fifth year. After that, the investment results in no further increases in cash flows. Assuming cash flows are evenly distributed throughout the year, the payback period for this investment is ______.

A. five years

B. four years

C. three and a half years

D. We cannot answer this question without knowing the cost of capital.

Answer 1

Payback period is calculated using the below formula:

Payback period= full years until recovery + unrecovered cost at the start of the year/cash flow during the year

                              = 3 years + $200,000 - $155,000/ $90,000

                              = 3 years + $45,000/ $90,000

                              = 3 years + 0.50

                              = 3.50 years.

Hence, the answer is option c.

          

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