Question

A company is considering the purchase of a new piece of equipment for $91,600. Predicted annual cash inflows from this investment are $37,000 (year 1), $29,500 (year 2), $18,500 (year 3), $12,500 (year 4) and $7,000 (year 5). The payback period is:

multiple choice:

3.00 years.

• 4.47 years.

• 2.53 years.

• 4.22 years.

• 3.53 years

Answer 1

Answer

3.53 years

Explanation:

Year	Total flow	Cumulative flow
0	$                    (91,600)	$            (91,600)
1	$                      37,000	$            (54,600)
2	$                      29,500	$            (25,100)
3	$                      18,500	$              (6,600)
4	$                      12,500	$                5,900
5	$                        7,000	$              12,900

It can be seen until year 3, cumulative cash flows are negative. In the 4th year, the cash flows became positive.

So, payback period lies between 3rd and 4th year.

In the 4th year, we earn $ 12,500 but the deficiency is only $6,600.

So payback period is 3 + (6,600 / 12,500) = 3+ 0.53 = 3.53 years.

In case of any doubt, please comment.