Question

Bill plans to open a self serve grooming center in a storefront. The grooming equipment will cost $420,000, to be paid immediately. Bill expects after tax cash inflows of $91,000 annually

for seven years, after which he plans to scrap the equipment (zero salvage value) and retire to the beaches of Nevis. The first cash inflow occurs at the end of the first year. Assume the required return is 11 percent. What is the project’s payback period?

a. between 2 and 3 years                           b. between 3 and 4 years

c. between 4 and 5 years                           d. between 5 and 6 years

Answer 1

Payback of Project =Year Before the Discounted Payback Period occurs+ cumulative cash flow in the                                                      Year before Recovery/Discounted cash flow in the year after recovery

Year	Cash Flow	Cumulative cash flow
0	-420000
1	91000	91000
2	91000	182000
3	91000	273000
4	91000	364000
5	91000	455000
6	91000	546000
7	91000	637000
8	91000	728000
9	91000	819000
10	91000	910000

The above calculation shows that in 4 years Rs.364000 has been recovered .Rs. 56000, is balance out of cash outflow. In the 5th year, the cash inflow is Rs. 91000. It means the pay-back period is 4 to 5 years, calculated as follows.

Payback period of Project A= 4 Year+(56000/91000)*12 Months

                                         =4 year+ 7.38 Months

The payback period is between 4th to 5 h years