Question

You are considering three independent​ projects: project​ A, project​ B, and project C. Given the cash flow information in the popup​ window, calculate the payback period for each. If you require a​ 3-year payback before an investment can be​ accepted, which​ project(s) would be​ accepted?

Initial Outlay   -1,100   -10,000   -5,500
Inflow year 1   600   4,000   2,000
Inflow year 2   300   4,000   2,000
Inflow year 3   100   4,000   4,000
Inflow year 4   200   4,000   4,000
Inflow year 5   500   4,000   4,000

Answer 1

HI

A payback is the time when projected future inflows are equal to its initial outflow.

For Project A

Y0 - -1100

Y1 cumulative cash flow = -1100 + 600 = -500

Y2 cumulative cash flow = -500 + 300 = -200

Y3 cumulative cash flow = -200 + 100 =-100

Y4 cumulative cash flow = -100 + 200 = 100

as we can see that cumulative cash flow is positive in 4th year

hence payback period = 3- (Y3 cumulative cash flow)/Y4 cash flow

=3 -(100)/200 = 3+0.5 = 3.5 years

Project B

Y1 cumulative = -10000+ 4000 = -6000

Y2 cumulative = -6000 + 4000 + -2000

Y3 cumulative = -2000+4000 = 2000

hence Payback period = 2 - (-2000)/4000 = 2+0.5 = 2.5

Project C

Y1 cumulative = -3500

Y2 cumulative = -1500

Y3 cumulative = -1500 + 4000 = 2500

Hence payback period = 2- (-1500)/400 = 2+15/40 = 2.375 years

So we will choose project B and C since there payback is less than 3 years

Thanks