Question

A firm is evaluating a proposal which has an initial investment of $35,000 and has cash flows of $10,000 in year 1, $20,000 in year 2, and $10,000 in year 3. The payback period of the project is

A) Between 2 and 3 years.
B) 1 year.
C) Between 1 and 2 years.
D) 2 years.

Answer 1

The payback period for the investment with cash inflows of $10,000, $20,000, and $10,000 over three years against an initial outlay of $35,000 is between 2 and 3 years, calculated by adding cash inflows until the initial investment is recovered.

Step-by-step explanation:

The payback period is a capital budgeting method that calculates the time required for an investment to generate cash flows sufficient to recover the initial outlay. To determine the payback period for the given investment of $35,000 with cash inflows of $10,000 in year 1, $20,000 in year 2, and $10,000 in year 3, we add up the cash flows year by year until we reach the initial investment amount. By the end of year 1, $10,000 has been recovered. By the end of year 2, an additional $20,000 has been recovered for a total of $30,000. Since this is less than the initial investment, we proceed to year 3. The full investment is covered by the end of year 3, meaning the payback period is between 2 and 3 years.

Therefore, the correct answer is A) Between 2 and 3 years.