Question

You are a Logistics Manager at an e-Commerce retail company. Your company currently uses third-party delivery services to deliver products ordered through your website. While third-party services are reliable, they have limitations that are preventing your company from differentiating from other e-Commerce retailers. Therefore, you are contemplating that your company should start its own delivery service for delivering the most commonly ordered products. You have done all the analyses and are left with calculating the payback period of the investment before you present it to management. Typically, management has funded investments with a payback period between 3 – 4 years.

What is the payback period of this investment based on the information provided below? Will management invest in this project?

Note: Please show all calculations and use only the information provided in this problem. Do not include any external information.

The required investment for the service is $800,000. You are expecting an increase in monthly revenue of $30,000 for the next 5 years that is directly attributable to this service. You are also expecting incremental costs of $175,000 per year for the next five years.

Answer 1

Initial investment required for setting up own delivery service = $800,000

Increase in monthly revenue = $30,000

Therefore, increase in annual revenue for next 5 years = (30,000*12) = $360,000

Incremental costs for the next 5 years = $175,000

Net Incremental Inflow/Revenue for the next 5 years by setting up own delivery service = (360,000-175,000) =$185,000.

.

Pay back period = Initial investment required for setting up own delivery service/Annual Incremental Revenue/Inflow

= 800,000/185,000

= 4.32 years

.

Alternatively, we can also calculate payback period as calculated below:

Year	Cashflow	Cummulative Cashflow	Remarks
0	-800000	-800000
1	185000	-615000
2	185000	-430000
3	185000	-245000
4	185000	-60000
5	185000	125000	Initial Investment recovered in year -5

= 4 + (60,000/185,000)

= 4 + 0.32

= 4.32 years

.

Conclusion:

Since management has funded investments with a payback period between 3 – 4 years , management will not invest in this project as this project has a payback period of 4.32 years i.e.greater than 4 years.