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A project has an initial cost of $10,000 and cash inflows of $2,000, $4,000, $6,000, and...

A project has an initial cost of $10,000 and cash inflows of $2,000, $4,000, $6,000, and $2,000 a year over the next four years, respectively. What is the payback period?

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Answer #1

Payback period is the number of years it takes to re-earn the cash amount invested.

Year 0: Cash flow = - $10,000 (negative since it is an outflow)

Year 1: Cash flow = $2,000. Cumulative cash flow = -$10,000 + $2,000 = -$8,000

Year 2: Cash flow = $4,000. Cumulative cash flow = -$8,000 + $4,000 = -$4,000

Year 3: Cash flow = $6,000. Cumulative cash flow = -$4,000 + $6,000 = $2,000

So, Year 3 is when the earned cash flow exceed invested amount.

In year 3, fraction of year required to complete payback = $4,000/$6,000 = 2/3 = 0.67 year

Payback = 2 + 0.67 years = 2.67 years

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