Question

The company is considering adding a new product line that will require an investment of $1,454,000.
      Management estimates that this investment will have a 10-year life and generate future net cash
      inflows of $310,000 the first year, $280,000 the second year and $240,000 each year thereafter for
      eight years. Compute the payback period. (Hint: the payback period does not use the time value           
      of money charts.)

Answer 1

When cash inflows are uneven, we need to calculate the cumulative net cash flow for each period and then use the following formula:

Payback Period =	A +	B
C

Where,
A is the last period number with a negative cumulative cash flow;
B is the absolute value (i.e. value without negative sign) of cumulative net cash flow at the end of the period A; and
C is the total cash inflow during the period following period A

Year	Annual Cash Flow	Cumulative Cash Flows
0	-14,54,000	-14,54,000
1	3,10,000	-11,44,000
2	2,80,000	-8,64,000
3	2,40,000	-6,24,000
4	2,40,000	-3,84,000
5	2,40,000	-1,44,000
6	2,40,000	96,000
7	2,40,000	3,36,000
8	2,40,000	5,76,000
9	2,40,000	8,16,000
10	2,40,000	10,56,000

Payback Period = 5 Year + ( 144,000/240,000)

= 5 Year + 0.6 Year

= 5.6 Year