Question

An entrepreneur is considering investing in a Bounce House business. The business rents space to kids and may be highly profitable. The entrepreneur wants his cash back within 4.00 years. The business will cost $111,332.00 for his equity stake. The business expects yearly sales of $796,036.00. The after-tax margin on these sales is 11.00%. The entrepreneur will get 40.00% of the after-tax margin each year.

What is the payback for this project?

Answer 1

The payback period represents the time period in which the initial investment of the project is recovered.

Amount each year that the entrepreneur will get is computed as follows:

= Sales x after tax margin x 40%

= $ 796,036 x 11% x 40%

= $ 35,025.584

The cumulative cash flows of the first 3 years is computed as follows:

= $ 35,025.584 x 3

= $ 105,076.752

The cumulative cash flows of the first 4 years is computed as follows:

= $ 35,025.584 x 4

= $ 140,102.336

It means that the investment is recovered between year 3 and year 4, which implies that the payback period lies between year 3 and year 4. So, the payback period will be:

= 3 years + Remaining investment to be recovered / Year 4 cash inflow

= 3 years + ( $ 111,332 - $ 105,076.752) / ($ 35,025.584 )

= 3 years + 0.178590827

= 3.18 years Approximately

Feel free to ask in case of any query relating to this question