Question

6. A project requires initial capital outlay of GH₡300,000. The project will provide annual cash flow of GH₡80,000 for 5 years. what is the payback period? *

Your answer

Answer 1

Payback period is the time period required to cover the initial investment back. In the payback period, the all cost will be covered and after that the profit will start incurring.

Note : It is assumed that all the cash flows are evenly distributed through out the year.

Initial investment = GH₡300,000

Cash flows are shown in the below table-

Year	Cash flow (in GH₡)	Cumulative cash flow (in GH₡)
1	80,000	80,000
2	80,000	1,60,000
3	80,000	2,40,000
4	80,000	3,20,000
5	80,000	4,00,000

Payback period = 3 + 60,000 / 80,000

= 3 + 0.75

= 3.75 years

( As the initial investment is GH₡300,000, we need to cover this cost, we will take year corresponding to the cumulative value which is less than or equal to GH₡300,000, here it is 3 year. In 3 year 240,000 $ will be covered, we will be needing GH₡60,000 (300,000 - 240,000) more to cover full initial cost. As the cash flows are evenly distributed, remaining 60,000 GH₡ will be covered from 4th year inflows of amount 80,000) . Hence 60,000 / 80,000 is taken.

Hence payback period = 3.75 years.

Hope it helps!