Question

Recovery period (Payback period) A company dedicated to the sale of solid wood for the manufacture of wooden cabinets and furniture is considering investing in a wood shaping machine that will produce the following cash flows in the coming years. The investment will be made in two years as indicated below.

1. Determine the period of recovery of the investment. 2. Indicates whether this method is an appropriate tool to determine if the company should make the investment or not and why.

Año Inversión Flujo de efectivo 1 $28,500 $1,500 2 $6,000 $3,000 $6,000 $6,750 $9,000 $7,500 $6,000 $4,500 $3,750 $3,750 9 10

Answer 1

1	Payback Period	=	6 years and 46 days
2	No, this method is not an appropriate tool for decision making i.e whether to make the investment or not
	As payback period focuses on the repayment of the Investment made but ignores time value of money while deciding whether to make investment or not other methods like Net present Value, Internal rate of return method proceeds over payback period method.
	Workings:
	Year	Investment	Cash Inflow	Cumulative Cash Flow
	1	$            -28,500	$             1,500	$                           -27,000
	2	$              -6,000	$             3,000	$                           -30,000
	3		$             6,000	$                           -24,000
	4		$             6,750	$                           -17,250
	5		$             9,000	$                             -8,250
	6		$             7,500	$                                 -750
	7		$             6,000	$                               5,250
	8		$             4,500	$                               9,750
	9		$             3,750	$                            13,500
	10		$             3,750	$                            17,250
	Payback Period	=	6 years + ($750 / $6000)
		=	6.125	years
	or	=	6 years + [($750 / $6000) X 365 days]
		=	6 years and 46 days