Question

Payback Period

Jan Booth is considering investing in either a storage facility or a car wash facility. Both projects have a five-year life and require an investment of $370,000. The cash flow patterns for each project are given below.

Storage facility: Even cash flows of $160,000 per year Car wash: $112,900, $143,200, $68,000, $127,000, and $97,000

Required: 1. Calculate the payback period for the storage facility (even cash flows). Round your answer to one decimal place.

years

2. Calculate the payback period for the car wash facility (uneven cash flows). Round your answer to three decimal places.

years

2b.Which project should be accepted based on payback analysis?

3. What if a third mutually exclusive project, a laundry facility, became available with the same investment and annual cash flows of $190,000?

3b.Now which project would be chosen?

Answer 1

Solution:

Payback period is the length of time within which an investment will return back to the company.

Part 1 –

Payback Period for the storage facility (even cash flows) = Initial Investment $370,000 / Even Cash Flow $160,000

= 2.3125 Years

Part 2 -

Payback Period for the car wash facility

Cash Wash	Cash Flows	Cumulative Cash Flows
Year 1	112900	112900
Year 2	143200	256100
Year 3	68000	324100
Year 4	127000	451100
Year 5	97000	548100

Initial Investment = $370,000

Payback Period = 3 Years + ($370,000 – 324100) / 127,000

= 3 Years + 0.36 Years

= 3.36 Years

Part 2(b) –

Storage Facility project should be accepted since it has lower payback period

Part 3 –

Payback Period = Initial Investment $370,000 / Annual Cash Flows $190,000

= 1.947 Years

Part 3(b) –

Laundry facility project should be accepted since it has lowest payback period.

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