Question

Builtrite is considering the purchase of a machine with the following cash flow diagram: year 0 spend $50,000 year 1 $30,000 year 2 $15,000 year 3 $20,000 year 4 $20,000 What is the payback period?

Answer 1

Payback period is the time period required to cover the initial investment back.

Initial investment = $50,000

Cashflows are shown in table below =

Year	Cashflow $	Cumulative cashflow $
1	30,000	30,000
2	15,000	45000
3	20,000	65000
4	20,000	85000

Note : It is assumed that all the cash flows are evenly distributed through out the year.

Payback period = 2 + 5000 / 20000

= 2 + 0.25

= 2.25 years

( As the initial investment is $50,000, we need to cover this cost, we will take year corresponding to the cumulative value which is less than or equal to 50,000, here it is 2 years.  In 2 years 45000 $ will be covered, we will be needing $5000 (50000 - 45000) more to cover full initial cost. As the cash flows are evenly distributed, remaining 5000 $ will be covered from 3rd year inflows of amount 20000$) . Hence 5000 / 20000 is taken.

Hope it helps!