Question

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

Answer 1

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