Question

There is a project with the following cash flows :

Year	Cash Flow
0	−$21,800
1	6,300
2	7,350
3	6,750
4	4,400

What is the payback period?

Multiple Choice

a. 4.00 years

b. 3.32 years

c. 3.74 years

d. 3.56 years

e. 2.79 years

Answer 1

What is the Payback period for Project?

Answer: 3.32years

When the annual cash flows are not uniform, the cumulative cash inflows from operations must be calculated for each year. The payback period shall be corresponding period when total of cumulative cash inflows is equal to the initial capital investment. However, if exact sum does not match then the period in which it lies should be identified. After that we need to compute the fraction of the year.

Initial capital investment = $21,800

Cash flows

Year	Cash flow	Cumulative cash flow
1	$6,300	$6,300
2	$7,350	$13,650
3	$6,750	$20,400
4	$4,400	$24,800

Payback period in this case will lie between year 3 and year 4. Since up to year 3 a sum of $20,400 has been recovered, balance of $1,400 (i.e. $21,800 – $20,400) shall be recovered in the part (Fraction) of 4^th year, Computation is as follows

            = (Balance recoverable ÷ Cash flow of year 4)

= ($1,400 ÷ $4,400)

            = 0.32 years

Payback period = 3.28 years

$20,400 will be received in 3years and cash flow of balance $1,400 (i.e. $21,800 – $20,400) will be received in 0.32year. So Total payback period will be 3.28 years