Question

Calculate the Payback Period and Discounted Payback Period for the following project:

1. An initial investment of $20,000 with expected after-tax operating cash flows of $125,000 per year for each of the next 3 years. However, in preparation for its termination at the end of year 3, an additional investment of $350,000 must be made at the end of Year 2.

Please show all work in excel.

Answer 1

Initial investment =$ 20,000

Investment 2nd year end = $ 3,50,000

Total investment = $ 3,70,000

Cash inflows after tax = 1,25,000+1,25,000+1,25,000

Total =$ 3,75,000

Cumulative cash inflows in year 2= 1,25,000+1,25,000

= 2,50,000

Required cash flow to cover-up initial investment:

= 3,70,000-2,50,000

= $1,20,000

1,25,000 = 12 months

1,20,000 = ? months

Months required = 11.52 months

Therefore payback period = 2 years 11.52 months.

Discounted payback period:

In question required return not given, so time value of money not calculated without required return.

Take eg: required return = 10%

Cash inflows

= 1,25,000*0.909+1,25,000*0.826+1,25,000*0.751

= 1,13,625+1,03,250+93,875

= $ 3,10,750.

Initial investment = 20,000

2nd year end investment = 3,50,000*0.826 = 2,89,100

Total investment = $ 3,09,100.

Cumulative cash inflow in year 2 = 1,13,625+1,03,250

= 2,16,875.

Required cash inflow to cover-up initial investment:

= 3,09,100-2,16,875 = $ 92,225

93,875 = 12 months

92,225 = ? Months required

Therefore =92,225*12/93,875 =11.79 months approximately.

Discounted payback period is 2 years 11.79 months.