Homework Answers
Answer
A) 3.2 years
Payback period is the time required to recover the initial cost of an investment. It is the number of years it would take to get back the initial investment made for a project. The project with the least number of years usually is selected.
Computation of payback period
|
Year |
Cash flows |
Cumulative cash flows |
|
0 |
-10,00,000 |
-10,00,000 |
|
1 |
2,00,000 |
-8,00,000(-10,00,000+2,00,000) |
|
2 |
4,00,000 |
-4,00,000(-8,00,000+4,00,000) |
|
3 |
3,00,000 |
-1,00,000(-4,00,000+3,00,000) |
|
4 |
5,00,000 |
4,00,000(-1,00,000+5,00,000) |
Step 1: we must pick the year in which the outflows have become positive. In other words, the year with the last negative outflow has to be selected. So in this case it is year 3
Step 2: Divide the total cumulative flow in the year in which the cash flows become positive by the total cash flow of the consecutive year.
So that is: 1, 00,000/5,00,000= 0.2
Step 3: step 1 +step 2 = the payback period =3.2 years
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