Question

ABC Company is considering an investment that will cost the company $460 at time=0. The after-tax cash flows are expected to be $104 each year for 7 years. What is the payback period?

Answer 1

Payback Period = Time Required for After-Tax Cash periodic Flows to cover the Initial Investment/Cost.

Initial Cost = $ 460 and After-Tax Periodic Cash Flows = $ 104

After Year 1:

Initial Cost Covered = After-Tax Cash Flows = $ 104

Initial Cost Uncovered = 460 - 104 = $ 356

After Year 2:

Initial Cost Covered = After-Tax Cash Flows = $ 104

Initial Cost Uncovered = 356 - 104 = $ 252

After 3:

Initial Cost Covered = After-Tax Cash Flows = $ 104

Initial Cost Uncovered = 252 - 104 = $ 148

After Year 4:

Initial Cost Covered = After-Tax Cash Flows = $ 104

Initial Cost Uncovered = 148 - 104 = $ 44

Payback Period = 4 (years) + [Initial cost uncovered / After-Tax Cash Flow of Year 5] = 4 + (44/104) = 4 + 0.4231 = 4.4231 years