Question

The Seattle Corporation has been presented with an investment opportunity which will yield cash flows of $30,000 per year in Years 1 through 4, $35,000 per year in Years 5 through 9, and $40,000 in Year 10. This investment will cost the firm $150,000 today, and the firm's cost of capital is 10%. Assume cash flows occur evenly during the year, 1/365th each day. What is the payback period for this investment? 1. 4.35 years 2. 3.35 years 3. 3.72 years 4. 4.86 years 5. 5.23 years

Answer 1

Answer:

Payback = 4.86 years

Explanation:

Payback is time it will take the company to recover the initial investment, which in this case is equal to $150,000.

Year  Cash-flow  Balance

0    (150,000)   (150,000)

1    30,000     (120,000)

2    30,000     (90,000)

3    30,000     (60,000)

4    30,000     (30,000)

5    35,000        5,000  

By end of year 5, the company has already recovered the $150,000 initial investment as seen through the positive cumulative balance

Payback = Years With Negative Cumulative Cash-flow Balance + $\frac{-LastNegativeBalance}{CashInflowfollowingYear}$

$=4+\frac{30,000}{35,000} =4,86years$