You are considering an investment which has the following cash ﬂows. If you require a four year payback period, should you take the investment?
A) Yes, the payback is 1.000 years.
B) Yes, the payback is 2.675 years.
C) Yes, the payback is 3.375 years.
D) No, the payback is 4.125 years.
E) No, the payback is 5.500 years.

Question

You are considering an investment which has the following cash ﬂows. If you require a four year payback period, should you take the investment? 
A) Yes, the payback is 1.000 years. 
B) Yes, the payback is 2.675 years. 
C) Yes, the payback is 3.375 years. 
D) No, the payback is 4.125 years. 
E) No, the payback is 5.500 years.

Quizplus · Accepted Answer

To calculate the payback period, we need to cumulate the cash flows until the total is greater than or equal to the initial investment.

Year 1 cash flow = $200 
Year 2 cash flow = $300 
Year 3 cash flow = $400 
Year 4 cash flow = $500 
Total initial investment = $1,000 
Cumulative cash flows:
Year 1: $200
Year 2: $500 ($200 + $300)
Year 3: $900 ($500 + $400)
Year 4: $1,400 ($900 + $500)

The payback period is the time it takes for the cumulative cash flows to equal the initial investment. In this case, it takes 3 full years and another $400/$500 in Year 4. The total amount of time needed to reach the payback is 3.375 years. Since this is less than the required 4-year payback period, we should take the investment.

You Are Considering an Investment Which Has the Following Cash