Beduin Services is considering an investment of $25,000. Data related to the investment are as follows: $\begin{array}{cr}
\text { Year } & \text { Cash Flow } \
\hline 1 & \$ 10,000 \
2 & 11,000 \
3 & 8,000 \
4 & 15,000 \
5 & 15,000
\end{array}$ Cost of capital is 14 percent. What is the payback period in years approximated to two decimal points, assuming no taxes are paid?

Question

Quizplus · Accepted Answer

The payback period is the time it takes for the cumulative cash flow to equal the initial investment. Here, the cumulative cash flow at the end of each year is as follows: Year 1: $10,000, Year 2: $21,000 ($10,000 + $11,000), Year 3: $29,000 ($21,000 + $8,000). Since the initial investment is $25,000, the payback period falls between Year 2 and Year 3. To find the exact payback period, we see that an additional $4,000 is needed in Year 3 to reach the initial investment of $25,000. Since $8,000 is earned in Year 3, it takes half a year to earn the additional $4,000 needed. Therefore, the payback period is 2.5 years.