Payback Period Payson Manufacturing is considering an investment in a new automated manufacturing system. The new system requires an investment of $1,200,000 and either has: Even cash flows of $300,000 per year or The following expected annual cash flows: $150,000, $150,000, $400,000, $400,000, and $100,000. Required: Calculate the payback period for each case. a. years b. years

a. 4 years

b. 5 years

Explanation:

The payback period is the time taken for the cash inflows from an investment to equal to the initial cash outflow or amount invested. To get this, the cash inflow are deducted from the outflows until the net is zero.

Considering both expected cash flows (all amounts in $);

Period Initial out flow Inflow Balance Inflow Balance

Year 0 (1,200,000) 0 (1,200,000) 0 (1,200,000)

Year 1 300,000 (900,000) 150,000 (1,050,000)

Year 2 300,000 (600,000) 150,000 (1,050,000)

Year 3 300,000 (300,000) 400,000 (1,050,000)

Year 4 300,000 0 400,000 (1,050,000)

Year 5 100,000 (1,050,000)

From the table above, with an inflow of $300,000 yearly, the inflows would equal the total outflow in 4 years while the annual cash flows: $150,000, $150,000, $400,000, $400,000, and $100,000 would make the inflows equal to the outflows in 5 years.

a) The payback period = 4 years

b) The payback period = 5 years

Explanation:

The payback period is the estimated length of time in years it takes

the net cash inflow from a project to equate and recoup the net cash the initial cost

a) Even cash flow

Where a project is expected to generate a series of equal annual net cash inflow, the payback period can be calculated as:

The initial invest / Net cash inflow per year

So the payback period for project X

= $1,200,000/$300,000

= 4 years

b) Uneven cash flow

With the streams of uneven cash flows, at the end of year 5, the project would have recouped

=150,000 + $150,000 + $400,000 + $400,000 + 100,000

= 1,200,000.00

The payback period = 5 years