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 $190,000 per year

Car wash: $112,500, $143,300, $69,000, $127,000, and $92,000

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

Answer 1

1.

Payback period for storage facilities = Initial investment/Annual cash inflow

= 370,000/190,000

= 1.9 years

2.

Calculation of payback period of car wash facility.

Year	Cash inflow	Cumulative cash inflow
0	-370,000	-370,000
1	112,500	-257,500
2	143,300	-114,200
3	69,000	-45,200
4	127,000	81,800
5	92,000	173,800

Since cumulative net cash inflow become positive in the 4th year, hence payback occurs in the 4th year.

Payback period refers to the time in which initial investment in the project is recovered.

Payback period = A + B/C

where,

A = Year full recovery

B = Unrecovered cost at the beginning of the last year

C = Cash flows in the following year

Payback period = 3 + 45,200/127,000

= 3 + 0.356

= 3.356 years

Payback period for car wash facility = 3.356 years

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