Question

The Seattle Corporation has been presented with an investment opportunity which will yield cash flows of $30,000 per year in Years 1 through 4, $35,000 per year in Years 5 through 9, and $40,000 in Year 10. This investment will cost the firm $150,000 today, and the firm's cost of capital is 10%. Assume cash flows occur evenly during the year, 1/365th each day. What is the payback period for this investment? 1. 4.35 years 2. 3.35 years 3. 3.72 years 4. 4.86 years 5. 5.23 years

Answer 1

Payback = 4.86 years

Step-by-step explanation:

Payback is time it will take the company to recover the initial investment, which in this case is equal to $150,000.

Year Cash-flow Balance

0 (150,000) (150,000)

1 30,000 (120,000)

2 30,000 (90,000)

3 30,000 (60,000)

4 30,000 (30,000)

5 35,000 5,000

By end of year 5, the company has already recovered the $150,000 initial investment as seen through the positive cumulative balance

Payback = Years With Negative Cumulative Cash-flow Balance +
`(-LastNegativeBalance)/(CashInflowfollowingYear)`

`=4+(30,000)/(35,000) =4,86years`