Question

Gourmet Cafe is considering opening a new location with an initial cost of $420,0000. This location is expected to generate cash flows of $118,000, $120,000, $122,000, $126,000, and $140,000 in Years 1 to 5. What is the payback period?

Answer 1

The payback period for Gourmet Cafe's new location is between year 3 and year 4, as the cumulative cash flows recover the initial investment of $420,000 during the fourth year.

Step-by-step explanation:

The question revolves around the concept of the payback period, which is a financial metric used to determine the time it takes for an investment to generate enough cash flow to recover the original investment cost. To calculate the payback period for Gourmet Cafe's new location, we would add the cash flows from each year until we reach the initial investment amount of $420,000.

1. Year 1: $118,000
2. Year 2: $120,000
3. Year 3: $122,000
4. Year 4: $126,000
5. Year 5: $140,000

By summing up the cash flows, we will determine that the initial investment cost is fully recovered sometime in Year 4:

• Year 1: $118,000
• Year 2: $238,000 (cumulative)
• Year 3: $360,000 (cumulative)
• Year 4: $486,000 (cumulative)

The payback period therefore falls between year 3 and year 4. Additional calculation is needed to find the exact time within the fourth year.