Question

Folsom Advertising, Inc. is considering an investment in a new information system. The new system requires an investment of $1,800,000 and either has

a. Even cash flows of $750,000 per year or
b. The following expected annual cash flows: $450,000, $225,000, $600,000, $600,000, and $150,000.

Required:
Calculate the payback period for each case

Answer 1

The payback period for case a is 2.4 years, and for case b it is 5 years.

Step-by-step explanation:

To calculate the payback period for an investment, we need to find the number of years it takes for the cumulative cash flows to equal or exceed the initial investment.

In case a, where the cash flows are $750,000 per year, we divide the initial investment of $1,800,000 by the annual cash flow of $750,000 to find the payback period: $1,800,000 / $750,000 = 2.4 years.

In case b, where the cash flows are $450,000, $225,000, $600,000, $600,000, and $150,000 per year, we calculate the cumulative cash flows until they equal or exceed the initial investment: $450,000 + $225,000 + $600,000 + $600,000 + $150,000 = $2,025,000. The payback period is then 5 years since it takes 5 years for the cumulative cash flows to exceed the initial investment.

Answer 2

Payback period=2 years 5 months

Payback period=3 years 8 months

Step-by-step explanation:

The payback period is the estimated length of time in years it takes .

It is the number of years it takes the cash project to break-even

a) Payback period

Total cash flow for two years = 750× 2 = 1500.000

Balance of cash flow required to make up= 1800000- 1500,000 300,000

Payback period = 2 years + 300,000/750,000× 12 months= 2 years 5 months

Payback period=2 years 5 months

b) Payback period

Total cash flow for 3 years = 450,000 + $225,000 +600,000=1,275 ,000

Balance o cash required to make up 1800,000 = 1,800,000 -1275,000= 525,000

Pay back period = 3 years + 525,000/750,000× 12 months

= 3 years 8 months

Payback period=3 years 8 months