BGG Limited is investing £700,000 into a new project today. The project will last for five years. A further investment into the project of £100,000 will be made at the end of year 3 of the project's life. At the end of the five years, all the project assets will be sold for £200,000. Depreciation on project assets is provided on the straight line basis over five years. The net cash inflows from the project in years 1 to 5 are expected to be £200,000, £220,000, £240,000, £280,000 and £260,000. What is the payback period for this project?

Question

Quizplus · Accepted Answer

The cumulative cash inflows are: Year 1: £200,000, Year 2: £420,000, Year 3: £660,000. By the end of Year 3, the total cash inflow is £660,000. An additional investment of £100,000 is made at the end of Year 3, making the total outflow £800,000. In Year 4, an additional £280,000 is received, bringing the cumulative inflow to £940,000. The payback period is reached during Year 4. The remaining £140,000 needed to break even is achieved in 6 months of Year 4 (£140,000/£280,000 = 0.5 years). Thus, the payback period is 3 years and 6 months.

BGG Limited Is Investing £700,000 into a New Project Today