Question

Payson Manufacturing is considering an investment in a new automated manufacturing system. The new system requires an investment of $1,200,000 and either has: Even cash flows of $300,000 per year or The following expected annual cash flows: $150,000, $150,000, $400,000, $400,000, and $100,000.

Calculate the payback period for each case.

Answer 1

The payback period for even cash flow is 4 years

The payback period for uneven cash flows is 5 years

Step-by-step explanation:

The payback period is a term used in capital budgeting and is one of the ways of assessing a project. It calculates the time required to recover the total cost invested in the project initially.

Payback period for Even cash flows

Payback period = Number of years till last period + Unrecovered cost at the beginning of the last period for payback / Total cash flows during the last period

The last period here refers to the period in which the cost will be recovered.

The initial cost is $1200000

Recovery till last year of payback = 300000 + 300000 + 300000 = $900000

Payback period = 3 + 300000 / 300000 = 4 years

Payback under uneven cash flows

Initial cost = $1200000

Recovery till last year of payback = 150000 + 150000 + 400000 +400000 = 1100000

Payback period = 4 + 100000 / 100000 = 5 years