Question

Assume a $70,000 investment and the following cash flows for two alternatives.

Year	Investment A			Investment B
1	$	20,000		$	35,000
2		25,000			25,000
3		20,000			20,000
4		20,000			—
5		25,000			—

a. Calculate the payback for investment A and B.

Answer 1

A:

Year	Cash flows	Cumulative Cash flows
0	(70,000)	(70,000)
1	20,000	(50,000)
2	25000	(25000)
3	20,000	(5000)
4	20,000	15,000
5	25,000	40,000

Payback period=Last period with a negative cumulative cash flow+(Absolute value of cumulative cash flows at that period/Cash flow after that period).

=3+(5000/20,000)

=3.25 years

B:

Year	Cash flows	Cumulative Cash flows
0	(70,000)	(70,000)
1	35000	(35000)
2	25000	(10,000)
3	20,000	10,000

Payback period=Last period with a negative cumulative cash flow+(Absolute value of cumulative cash flows at that period/Cash flow after that period).

=2+(10,000/20,000)

=2.5 years