Question

A small accounting firm is considering the purchase of a computer software package that would greatly reduce the amount of time needed to prepare tax forms. The software costs $2250 and this expense will be incurred immediately. The firm estimates that it will save $525 at the end of each year beginning in one year for 4 consecutive years, and also save $1444 in year 5. What is the payback on the computer package?

Answer 1

Payback period:

Payback period is the period in which initial investment is recovered.

PBP = Year in which least +ve Closing Balance + [ Closing balance at that year / Cash flow in Next Year ]
If Actual PBP > Expected PBP - Project will be rejected
Actual PBP </= Expected PBP - Project will be accepted

Year	Opening Balance	Cash Flow	Closing Balance
1	$            2,250.00	$            525.00	$          1,725.00
2	$            1,725.00	$            525.00	$          1,200.00
3	$            1,200.00	$            525.00	$             675.00
4	$               675.00	$            525.00	$             150.00
5	$               150.00	$         1,444.00	$        -1,294.00

PBP = Year in which least +ve Closing Balance + [ Closing balance at that year / Cash flow in Next Year ]
= 4 Years + [ $ 150 / $ 1444 ]
= 4 Years + 0.1 Years
= 4.1 Years

Payback Period is 4.1 Years

PBP Refer Payback Period