Question

An anticipated purchase of equipment for $500,000, with a useful life of 8 years and no residual value, is expected to yield the following annual net incomes and net cash flows:

Year	Net Income	Net Cash Flow
1	$60,000	$120,000
2	50,000	110,000
3	50,000	110,000
4	40,000	100,000
5	40,000	60,000
6	40,000	60,000
7	40,000	60,000
8	40,000	60,000

What is the cash payback period?

Answer 1

The Payback period (nothing but the traditional or conventional recovery period) is the period within which, cash outflows associated with the project can be recovered by the management but without considering time value of money. The answer is expressed in terms of number of periods (may be weeks or months or years, etc.). To calculate the payback period, cumulative cash flows year-by-year shall be calculated and then the year in which cumulative cash flows turns into positive is the payback period. However, in order to calculate exact payback period in decimal places, negative cumulative cash flows of previous year shall be divided by current year's cash flows and the decimal thus calculated shall be added to previous year to the year in which cumulative cash flows turned into positive NetAccumulated Cash Flow Net Cash Flow Year CONCLUSION: It is observed that the accumulated net cash flows turns into zero in year-5 Therefore, $500,000$500,000 1 $120,000 -$380,000 -$500000+$120000] 2 $110,000 -$270,000 I-$380000 $110000] 3 $110,000 -$160,000 I-$270000 $110000] 4 $100,000 $60,000 -$160000$100000] 5 6 $60,000 $60,000 S0 $60000] 7 $60,000 $120,000 S60000+ $60000] 8 $60,000 $180,000 [$120000 $60000] Payback period5 years $60,000 $0 L-$60000+ $60000] NOTE Fo calculating payback period, net income data is irrelevant and so not considered