Question

It will cost $9,600 to acquire an ice cream cart that is expected to produce cash inflows of $3,600 a year for three years. After the three years, the cart is expected to be worthless. What is the payback period?

Answer 1

Payback period is the number of years it will take for the recovery of initial cost of the project. The initial investment is of $9,600. It will produce cash inflows of $3,600 per year for 3 years. The salvage value is zero Calculate the cumulative cash flows as follows: Cash flow Cumulative cash $3,600 $3,600(S3,600+S3,600) $3,600(S7,200+S3,600) Year flows $3,600 -$7,200 -$10,800 The initial cost is $9,600. The amount of $7,200 is recovered in the first 2 years. The remaining amount of $2,400 (S9,600-$7,200) will be recovered somewhere in between year 2 and year 3. Calculate the proportional year in which initial cost is recovered as follows:

(Initial cost-Cunulative cash flow at year 2) (Cumulativecash flow at year 3-Cumulative cash flow at year2) ($9,600-$7.200) ($10,800-$7.200) $2,400 $3,600 0.6666666 Calculate the payback period as follows: Pay back period-2years+proportionalyear 2 years+0.66666 year 2.66666 year Thus, the payback period is 2.67 year