Question

There is a project with the following cash flows : Year Cash Flow

year Cash Flow

0 −$23,050

1 6,700

2 7,800

3 6,950

4 7,550

5 6,300

What is the payback period?

Answer 1

Ans : Payback Period (PBP) is time taken to recover the cost of Investment.

Calculation of Payback Period

Year	Cash Flows	Cumulative Cash Flows
0	$(23,050)	$(23,050)
1	6,700	(16,350)
2	7,800	(8,550)
3	6,950	(1,600)
4	7,550	5,950
5	6,300	12,250

In Year 4 the pending initial investment of 1600 was recovered.

PBP = Y + CCF / CF

where,

Y = last time period where the cumulative cash flow was negative
CCF = Cumulative Cash Flow of the period in which cumulative cash flow was last negative (i.e of period Y)
CF = Cash Flow of the period following the period in which cumulative cash flow was last negative (i.e of period Y)

PBP = 3 + 1600 / 7550
= 3 + 0.211
= 3.21 years

Ans : Payback Period = 3.21years