What is the payback period for the following set of cash flows?

 

Year Cash Flow
0 −$ 4,600
1 1,800
2 2,500
3 2,500
4 1,400
Solution

To calculate the payback period, we need to find the time that the project has recovered its initial investment. After two years, the project has created:

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$1800 + $2500 = $4300

 

in cash flows. The project still needs to create another:

 

$4,600 − 4,300 = $300

 

in cash flows. During the third year, the cash flows from the project will be $2,500. So, the payback period will be 2 years, plus what we still need to make divided by what we will make during the third year. The payback period is:

 

Payback = 2 + ($300/$2,500)
Payback = 2.12 years