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 $390,000. The cash flow patterns for each project are given below.

Storage facility: Even cash flows of $120,000 per year

Car wash: $112,600, $143,100, $69,000, $127,000, and $98,000

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

Which project should be accepted based on payback analysis?

3. What if a third mutually exclusive project, a laundry facility, became available with the same investment and annual cash flows of $150,000?

Now which project would be chosen?

Answer 1

Answer

1.

Payback Period = Initial Outflow / Annual Cash Inflow

= $390,000 / 120,000 per year

Payback Period = 3.25 Years

2.

Year	Cash Inflow	Cumm. Cash Flow
1	112,600.00	112,600.00
2	143,100.00	255,700.00
3	69,000.00	324,700.00
4	127,000.00	451,700.00
5	98,000.00	549,700.00

As it can be seen that the $390,000 will be received between 3 and 4 Years

Payback Period = 3 Years + Remaining Cash Flow / Inflow in that year

= 3 + {(390,000 – 324,700) / 127,000}

= 3 + 0.514

Payback Period = 3.51 Year

It is recommended to accept Storage facility as payback period is less in that case.

3.

Payback period of 3^rd project = $390,000 / 150,000

= 2.6 Years

It is recommended to accept the new project as payback period is least in this case.

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