Joe is considering setting up a business selling free-range chickens.He estimates his establishment costs will be $600,000 and his net cash flows for the first five years will be $100,000 in year 1,$200,000 in year 2,stabilising at $250,000 in year 3.The payback period for the investment is:

Question

Quizplus · Accepted Answer

Payback period is the time it takes for the initial investment to be recovered through the net cash flows. To calculate the payback period, we add the net cash flows until the cumulative cash flows equal the initial investment. 
In this case, the cumulative net cash flows will be 100,000 + 200,000 + 250,000 + 250,000 + 250,000 = 1,050,000. 
To recover the initial investment of $600,000, we need 600,000/1,050,000 = 0.57 or approximately 0.6 years of the 5 years. 
Therefore, the payback period is 2 years + 0.6 years = 2.6 years or 3.2 years (rounded to one decimal place). 
Thus the correct choice is B.

Joe Is Considering Setting Up a Business Selling Free-Range Chickens