Question

Advance Engineering is considering opening a new location with an initial cost of $398,0000. This location is expected to generate cash flows of $117,000, $121,000, $126,000, $133,000, and $142,000 in Years 1 to 5. What is the payback period?

Answer 1

Payback period is period in which initial investment is fully recovered.

Year	Cashflow	Cumulative cashflow
0	-       398,000	-       398,000
1	117,000	-       281,000
2	121,000	-       160,000
3	126,000	-         34,000
4	133,000	99,000
5	142,000	241,000

Since cumulative cashflow becomes positive at the end of year 4, payback period is somewhere between year 3 and year 4

Therefore payback period = 3 years + 34000 / 133000 = 3.26 years that is 3 years and 3 months approx

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