Payback period

ggordster

Hi i am trying to calculate payback but cant seem to get the same answer that is in the book. The capital expenditure is £125 year 1 revenue £85, year 2 £110, year 3 £130... the answer in the book is 2 years 7 months but i cannot get that answer.....help

SandyHood

To start the project you have a cumulative net cash flow of -£125, when the first year is over you'll have received £85 and the cumulative net cash flow will be -£40, when the second year is over you'll have received another £110 giving a cumulative net cash flow of £70. Effectively the payback period is at some point in year 2. The point is found by taking the £40 still not yet paid back and divide by the total yearly cash flow in the 2nd year of £110 = 0.3636 years then multiply by 12 months to get the answer of 1 year and 4 months.

The answer is not 2 years 7 months.

Occassionally some students add up all the inflows and divide their answer by the initial investment. I guess your answer has been done that way.
It takes less than 2 years afterall £85 +£110 > £125.

You are right to challenge the answer in your book.

Have a look at chapter 11 of http://eu.dummies.com/store/product/Management-and-Cost-Accounting-For-Dummies-UK-Edition.productCd-1118650492.html
This chapter addresses investment appraisal
And feel free to criticise me if I've made any mistakes