Question

1) If a project cost is $100,000 and you get a cash flow of $30,000 in year 1, $40,000 in year 2, and $50,000 in year three. What is the payback period?

Answer 1

Payback Period calculation gives us an idea that how long it will take for a project to recover the initial investment.

We can use cumulative cash flow table to see that when the cumulative cash flow is equal to zero (or non-negative).

Year	Cash Flow	Cumulative Cash Flow
0	-$100,000	-$100,000
1	$30,000	-$70,000
2	$40,000	-$30,000
3	$50,000	$20,000

We can see from above table that at the end of year 2 the initial investment is not recovered, so the payback period is greater than 2 year and can be calculated in following manner

Payback Period for project = last year of negative cumulative cash flow + (absolute value of last year of negative cumulative cash flow / Cash flow of next year after negative Cumulative Cash Flow)

= 2 + ($30,000/ $50,000) = 2 + 0.60 = 2.60 years

The payback period is 2.60 years.