Consider the following three-year project.The initial after-tax outlay or after-tax cost is $1,500,000.The future after-tax cash inflows for years 1,2,3 and 4 are: $800,000,$800,000,$300,000 and $100,000,respectively.What is the payback period without discounting cash flows?
A)1.875 years
B)2.0 years
C)3.5 years
D)4.125 years

Question

Quizplus · Accepted Answer

The payback period is the time it takes for the project to recover its initial investment. Here, in the first year, the project recovers $800,000, and in the second year, another $800,000, totaling $1,600,000, which exceeds the initial investment of $1,500,000. To find the exact payback period, we calculate the fraction of the year needed to recover the remaining $700,000 after the first year. Since the project fully recovers its initial investment by the end of the second year, the payback period is 1 year plus the fraction of the second year needed to recover the remaining $700,000. However, the calculation provided was incorrect in determining the exact fraction of the year needed; the correct calculation should consider the cash inflows and the point at which the initial investment is fully recovered. Given the inflows, the project recovers its initial cost between the first and second years, specifically, it takes less than 2 years, making the closest correct answer 1.875 years based on the options provided.

Consider the Following Three-Year Project