Question

The management of Unter Corporation, an architectural design firm, is considering an investment with the following cash flows: 

Year	Investment	Cash Inflow
1	$69,000	$4,000
2	$9,000	$8,000
3		$9,000
4		$10,000
5		$13,000
6		$11,000
7		$14,000
8		$12,000
9		$11,000
10		$11,000

Required:

 1. Determine the payback period of the investment.

 2. Would the payback period be affected if the cash inflow in the last year were several times as large?

Answer 1

total investment to be recovered = 69,000+9,000 =>$78,000.

year	cash flow	cumulative cashflow
1	4000	4000
2	8000	4000+8000=>12,000
3	9000	12,000+9000=>21,000
4	10,000	21,000+10,000=>31,000
5	13,000	31,000+13,000=>44,000
6	11,000	44,000+11,000=>55,000
7	14,000	55,000+14,000=>69,000
8	12,000	69,000+12,000=>81,000

so payback period is between 7th and 8 th year.

payback period = 7 th year + (78,000-69,000) / 12,000

=>7 + 9000/12000

=>7.75

=>7.8 years.

payback period = 7.8 years

b.No.

payback period will not take into account the magnitude of cashflows once the initial investment is recovered.

So the cash flows after 7.8 years in the given problem do not count.