Wednesday, 9 July 2014

What is the payback period for the following set of cash flows? (Round your answer to 2 decimal places. (e.g., 32.16))

What is the payback period for the following set of cash flows? (Round your answer to 2 decimal places. (e.g., 32.16))

Year Cash Flow
0 –$ 5,600
1 1,325
2 1,525
3 1,925
4 1,425


  Payback period years  


Explanation:
To calculate the payback period, we need to find the time that the project has recovered its initial investment. After three years, the project has created:
$1,325 + 1,525 + 1,925 = $4,775
in cash flows. The project still needs to create another:
$5,600 – 4,775 = $825
in cash flows. During the fourth year, the cash flows from the project will be $1,425. So, the payback period will be three years, plus what we still need to make divided by what we will make during the fourth year. The payback period is:
Payback = 3 + ($825 / $1,425) = 3.58 years