Question

You have been asked to analyze a capital investment project for a new machine. The machine will cost $400,000, have an 8-year life and a salvage of $80,000. The new machine will generate annual net cash flows of $120,000. The payback period is:

Multiple Choice

A. 3.25 years.

B. 3.33 years.

C. 3.50 years.

D. 3.67 years.

Answer 1

Payback Period = ( Last Year with a Negative Cash Flow ) + [( Absolute Value of negative Cash Flow in that year)/ Total Cash Flow in the following year)]

= 3 + (40,000 /120,000)

= 3.33 years

Hence the correct answer is B. 3.33 years.

Note:

Year	Investment	Cash Inflow	Net Cash Flow
0	-4,00,000	-	-4,00,000	(Investment + Cash Inflow)
1	-	1,20,000	-2,80,000	(Net Cash Flow + Cash Inflow)
2	-	1,20,000	-1,60,000	(Net Cash Flow + Cash Inflow)
3	-	1,20,000	-40,000	(Net Cash Flow + Cash Inflow)
4	-	1,20,000	80,000	(Net Cash Flow + Cash Inflow)
5	-	1,20,000	2,00,000	(Net Cash Flow + Cash Inflow)
6	-	1,20,000	3,20,000	(Net Cash Flow + Cash Inflow)
7	-	1,20,000	4,40,000	(Net Cash Flow + Cash Inflow)
8	-	2,00,000	6,40,000	(Net Cash Flow + Cash Inflow)