Question

Situation: You are deciding to start a delivery business in January 2020. The initial investment includes a small truck which costs $70,000. Other expenses were included in the expected cash flows. The truck has a useful life of 5 years and an estimated residual value at the end of the year of $10,000 (the amount expected the truck can be sold). Depreciation is the only non-cash expense. The net cash flows of each year in the following 5 years are estimated as follows: Initial investment: $70,000 Net cash flow year 1: (20,000) Net cash flow year 2: 10,000 Net cash flow year 3: 20,000 Net cash flow year 4: 40,000 Net cash flow year 5: 30,000 Estimated sale of truck year 5: 10,000 Question 2: If your required payback period is 3 years, what would be your decision based on the payback period? (calculate the payback period in years rounded using 2 decimals) Year Cash Flow Accum. Cash flow Payback Period Decision? Why?

Answer 1

Answer

Year	Cash Flow	Accum Cash Flow
1	($20,000)	($20,000)
2	$10,000	($10,000)
3	$20,000	$10,000
4	$40,000	$50,000
5	$30,000	$80,000
Payback period = 4 years + ($20000 / $ 30000)		4.67
Decision? Why?= If the required payback period is 3 years, the decision would be to REJECT the investment decision because actual payback period = 4.67 years (which is more than 3 years)