Sunday, 3 August 2014

Problem 8-1 Calculating Payback [LO 1] Consider the following cash flows: Year Cash Flow 0 –$6,800 1 1,950 2 4,100 3 1,750 4 1,450

Problem 8-1 Calculating Payback [LO 1]
Consider the following cash flows:

Year Cash Flow
0 –$6,800        
1 1,950        
2 4,100        
3 1,750        
4 1,450        


Required:
What is the payback period for the above set of cash flows? (Do not round intermediate calculations. Round your answer to 2 decimal places (e.g., 32.16).)

  Payback period years  


Explanation:
To calculate the payback period, we need to find the time the project needs to recover its initial investment. After two years, the project has created:
 
$1,950 + 4,100 = $6,050
 
in cash flows. The project still needs to create another:
 
$6,800 – 6,050 = $750
 
in cash flows. During the third year, the cash flows from the project will be $1,750. So, the payback period will be 2 years, plus what we still need to make divided by what we will make during the third year. The payback period is:
 
Payback = 2 + ($750 / $1,750)
Payback = 2.43 years