Question

The CEO just announces that all capital budgeting projects must meet a payback threshold of four years. What is the project’s payback period? Will you accept the project? Comment

Answer 1

The payback period is the number of years that a project will take to recover it's initial investment. The higher the payback period, the lower is the chances of the project to be accepted on the basis of the payback period.

For example, if the payback period is 4.5 years and the threshold decided by the management us 4 years. Then , the project cannot be accepted.

Inital cash outflow : $2,00,000

cash inflow : $50,000

$80,000

$30,000

$20,000

$40,000

In this example, the payback period is :

=4 + $20,000/ $40,000

= 4.5 years

$180,000 is recovered in the first 4 years, so the remaining $20,000 is recovered from the cahs inflow of $40,000 in the 5th year.

So, as the proejct payback period is more than the threshold payback period, this proeject should be rejected.