An investment of $42,000 is expected to generate the following annual cash flows:
$\begin{array}{ll}
\text { Year 1 } & \$ 10,000 \
\text { Year 2 } & \$ 15,000 \
\text { Year 3 } & \$ 15,000 \
\text { Year 4 } & \$ 12,000
\end{array}$
Assume straight-line depreciation is used.Ignore income taxes.What is the payback period?

Question

Quizplus · Accepted Answer

The payback period is the time it takes for the investment to generate cash flows to recover the initial investment. By adding the annual cash flows, we find that by the end of Year 3, the total cash flow is $40,000 ($10,000 + $15,000 + $15,000), which is short of the initial investment of $42,000. In Year 4, the cash flow is $12,000, but only $2,000 is needed to reach the initial investment. Therefore, the payback period extends into Year 4. To find the exact time into Year 4, divide the remaining amount ($2,000) by the Year 4 cash flow ($12,000), resulting in 1/6 of a year or approximately 0.17 years. Thus, the payback period is 3 years plus approximately 0.17 years, totaling 3.17 years.

An Investment of $42,000 Is Expected to Generate the Following