Question

What is the payback period for the following set of cash flows?

  

Year	Cash Flow
0	−$ 5,000
1	2,700
2	1,200
3	1,900
4	2,300

Answer 1

To calculate the payback period, we need to find the time that the project has recovered its initial investment. After two years, the project has created:

$2,700 + $1,200 = $3,900

in cash flows. The project still needs to create another:

$5,000 - $3,900 = $1,100

in cash flows. During the third year, the cash flows from the project will be $1,900. So, the payback period will be two years, plus what we still need to make divided by what we will make during the third year. The payback period is:

Payback = 2 + ($1,100 / $1,900) = 2.58 years