Creighton, Inc. has invested $2,165,800 on equipment. The firm uses payback period criteria of not accepting any project that takes more than four years to recover costs. The company anticipates cash flows of $424,386, $512,178, $561,755, $764,997, $816,500, and $825,375 over the next six years. What is the payback period, and does this investment meet the firm's payback criteria? (Round your answer to two decimal places.)

Question

Quizplus · Accepted Answer

3.87 years; yesTo calculate the payback period, we sum the cash flows until the initial investment is recovered. Summing the cash flows for the first four years: $424,386 + $512,178 + $561,755 + $764,997 = $2,263,316. This exceeds the initial investment of $2,165,800, indicating the investment is recovered in less than four years. To find the exact payback period, we calculate the partial year needed to recover the remaining amount after the third year. After three years, the total cash flow is $424,386 + $512,178 + $561,755 = $1,498,319, leaving $667,481 ($2,165,800 - $1,498,319) to be recovered in the fourth year. Since the fourth year's cash flow is $764,997, the fraction of the fourth year needed to recover the full investment is $667,481 / $764,997 ≈ 0.87. Therefore, the payback period is approximately 3 years + 0.87 year = 3.87 years. This meets the firm's criteria of not accepting projects with a payback period of more than four years.