why do they sum net cash flows instead of net income?
An anticipated purchase of equipment for $490,000 with a useful life of 8 years and no residual value is expected to yield the following annual net incomes and net cash flows:
Year | Net Income | Net Cash Flow | ||
1 | $60,000 | $110,000 | ||
2 | 50,000 | 100,000 | ||
3 | 50,000 | 100,000 | ||
4 | 40,000 | 90,000 | ||
5 | 40,000 | 90,000 | ||
6 | 40,000 | 90,000 | ||
7 | 40,000 | 90,000 | ||
8 | 40,000 | 90,000 |
What is the cash payback period?
a.5 years
b.4 years
c.3 years
d.6 years
Payback period for uneven cash flows is calculated by the following formula
Payback Period = |
A + |
B |
C |
Where,
A is the last period number with a negative cumulative
cash flow;
B is the absolute value (i.e. value without negative sign)
of cumulative net cash flow at the end of the period A; and
C is the total cash inflow during the period following
period A
The following table shows the calculations :
Year | Cash Flows | Cumulative Cash Flows |
0 | -490000 | -490000 |
1 | 110000 | -380000 |
2 | 100000 | -280000 |
3 | 100000 | -180000 |
4 | 90000 | -90000 |
5 | 90000 | 0 |
6 | 90000 | 90000 |
7 | 90000 | 180000 |
8 | 90000 | 270000 |
So, as per above equation, Payback period
= 4 + |-90,000 | / 90,000
= 4 + 1
= 5 Years
So, as per above calculations, option a is the correct option
why do they sum net cash flows instead of net income? An anticipated purchase of equipment...
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