Stern Associates is considering a project that has the follo

Stern Associates is considering a project that has the following cash flow data. What is the project’s payback? Year 0 1 2 3 4 5 Cash flows $1,100 $300 $310 $320 $330 $340 A. 2.31 years B. 2.56 years C. 2.85 years D. 3.16 years E. 3.52 years

Solution

Correct Answer is E. 3.52 years

Calculation of Payback Period (when annual inflow is different)

Year

Cash Flow

Cumulative Cash Flow

1

$300

$300.00

2

$310

$610.00

3

$320

$930.00

4

$330

$1,260.00

5

$340

$1,600.00

Initial Investment (Cost of Project) = $1,100

Payback period is the length of time within which initial investment of the firm is returned back.

From the cumulative cash inflow table above, it is clear the $1,100 is returned back to the company between Year 3 and Year 4. Hence the payback period is also between year 3 and year4.

Payback Period = 3 years + ($1,100 - $930) / $330

= 3 Years + 0.515 years

= 3.52 years