Question

King Co. invests $105,000 and the following cash flows for two investments:

Year	Investment A		Investment B
1	$30,000		$40,000
2	25,000		30,000
3	20,000		35,000
4	30,000		—
5	4,300,000		—

Calculate the payback period for investment A and B (in yrs)

Answer 1

A:

Year	Cash flows	Cumulative Cash flows
0	(105,000)	(105,000)
1	30,000	(75,000)
2	25,000	(50,000)
3	20,000	(30,000)
4	30,000	0
5	4,300,000	4,300,000

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

=4 years

B:

Year	Cash flows	Cumulative Cash flows
0	(105,000)	(105,000)
1	40,000	(65000)
2	30,000	(35,000)
3	35,000	0

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 years