Seattle Inc. identified an investment opportunity that requires an initial cash outflow of $150,000. Seattle's required rate of return is 10 percent. The investment 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. Assume the cash flows occur evenly during the year. What is the traditional payback period for this investment?

Question

Quizplus · Accepted Answer

The traditional payback period is calculated by adding the annual cash flows until the initial investment is recovered. For the first 4 years, the cash flow is $30,000 per year, totaling $120,000. The remaining $30,000 of the initial investment is covered in the 5th year by the $35,000 cash flow. To find the exact payback period, divide the remaining amount to be recovered ($30,000) by the cash flow in year 5 ($35,000), which gives 0.86 years. Adding this to the 4 years gives a total payback period of 4.86 years.