Question

Exercise 13-1 Payback Method [LO13-1]

The management of Unter Corporation, an architectural design firm, is considering an investment with the following cash flows:

Year	Investment		Cash Inflow
1	$	75,000	$	6,000
2	$	7,000	$	12,000
3			$	18,000
4			$	17,000
5			$	20,000
6			$	18,000
7			$	16,000
8			$	14,000
9			$	10,000
10			$	13,000

Required:

1. Determine the payback period of the investment.

2. Would the payback period be affected if the cash inflow in the last year were several times as large?

Answer 1

1. Payback Period = ( Last Year with a Negative Cash Flow ) + [( Absolute Value of negative Cash Flow in that year)/ Total Cash Flow in the following year)]

= 5+ ( 9,000 / 18,000 )

= 5.50 Years

Hence the correct answer is 5.50 Years

Year	Investment	Cash Inflow	Net Cash Flow
1	-75,000	6,000	-69,000	(Investment + Cash Inflow)
2	-7,000	12,000	-64,000	(Net cash Flow +Investment + Cash Inflow)
3	-	18,000	-46,000	(Net Cash Flow + Cash Inflow)
4	-	17,000	-29,000	(Net Cash Flow + Cash Inflow)
5	-	20,000	-9,000	(Net Cash Flow + Cash Inflow)
6	-	18,000	9,000	(Net Cash Flow + Cash Inflow)
7	-	16,000	25,000	(Net Cash Flow + Cash Inflow)
8	-	14,000	39,000	(Net Cash Flow + Cash Inflow)
9	-	10,000	49,000	(Net Cash Flow + Cash Inflow)
10	-	13,000	62,000	(Net Cash Flow + Cash Inflow)

2. The correct answer is No.

The payback period would not be affected if the cash inflow in the last year were several times as large. This is because the payback period is 5.50 Years and the last cash flow would occur in the 10th Years and hence the payback would not be affected.