Question

# What is the payback period for the following set of cash flows? Year Cash flow 0...

What is the payback period for the following set of cash flows?

 Year Cash flow 0 -\$40,000 (it is minus!) 1 \$10,000 2 \$5,000 3 \$20,000 4 \$5,000 5 \$10,000
 A. 2 years B. 4 years C. 3 years D. 1 year E. 5 years

Ans: Payback period B) 4 years

Calculation of Pay back Period

 Year Cash Flow Cumulative Cash Flow 0 \$(40,000.00) \$(40,000.00) 1 \$10,000.00 \$(30,000.00) 2 \$5,000.00 \$(25,000.00) 3 \$20,000.00 \$(5,000.00) 4 \$5,000.00 \$- 5 \$10,000.00 \$10,000.00

Step 1 : Calculate the Cumulative net cash flow.

Step 2 : Calculation of Pay back Period

Payback Period = A +B/C

where,
A is the last period number in which cash flow is negative or 0 (i.e.. 4)
B is the absolute cumulative net cash flow ignoring negative sign at the end of the period A (i.e. 0)
C is the total cash inflow during the period next to period A  (i.e. 10,000)

Payback Period = 4 + 0 / 10000
Payback Period = 4 years