Question

A 3-year project costs $800 and has cash inflows of $500 in Year 1, $400 in Year 2, and $300 in Year 3. What is the project’s payback period?

Group of answer choices

1.75 years

2.00 years

3.25 years

2.50 years

Answer 1

To calculate the payback period, we need to find the time that the project has recovered its initial investment. After 1 year, the project has created:

$500

in cash flows. The project still needs to create another:

$800 - $500 = $300

in cash flows. During the second year, the cash flows from the project will be $400. So, the payback period will be 1 year, plus what we still need to make divided by what we will make during the second year. The payback period is:

Payback = 1 + ($300 / $400) = 1.75 years