Question

What is the payback period for the following set of cash flows?

Year	Cash Flow
0	−$ 2,400
1	1,300
2	1,300
3	1,600
4	2,300

1.85 years

2.15 years

1.87 years

1.80 years

1.94 years

Answer 1

A. 1.85 years

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

$1,300

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

$2,400 − $1,300 = $1,100

in cash flows. During the second year, the cash flows from the project will be $1,300. 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 + ($1,100 / $1,300) = 1.85 years