An investment project requires a net investment of $100,000. The project is expected to generate annual net cash inflows of $28,000 for the next 5 years. The firm's cost of capital is 12%. Determine the payback period for the project.
A) 0.28 years
B) 1.4 years
C) 3.57 years
D) 17.86 years

Question

Quizplus · Accepted Answer

To calculate payback period, we need to find out how long it takes for the initial investment to be recovered.

Year 1 cash inflow = $28,000
Year 2 cash inflow = $28,000
Year 3 cash inflow = $28,000
Year 4 cash inflow = $28,000
Year 5 cash inflow = $28,000

Total cash inflows after Year 1 = $28,000
Total cash inflows after Year 2 = $56,000
Total cash inflows after Year 3 = $84,000
Total cash inflows after Year 4 = $112,000
Total cash inflows after Year 5 = $140,000

Since the net investment is $100,000, the payback period can be calculated as follows:

Payback period = Year before full recovery + (Unrecovered cost at start of year / Cash inflow during year)

Payback period = 3 + (($100,000 - $84,000) / $28,000)
Payback period = 3.57 years

Therefore, the best choice is C.

An Investment Project Requires a Net Investment of $100,000