Question

Consider a project that requires an initial investment of $502, pays $106 one year from today (at t = 1), pays $202 two years from today (at t = 2), and pays $353 three years from today (at t = 3). Rounded an accurate to three decimal places, what is the payback period for this project? (Example: if we had a much longer-term project of nine years, and you found the payback period was 7.2345 years...your answer would be entered as 7.235.).

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	$               502.00	$            106.00	$             396.00
2	$               396.00	$            202.00	$             194.00
3	$               194.00	$            353.00	$           -159.00

PBP = Year in which least +ve Closing Balance + [ Closing balance at that year / Cash flow in Next Year ]
= 2 Years + [ $ 194 / $ 353 ]
= 2 Years + 0.55 Years
= 2.55 Years

Payback Period is 2.55 Years