Cepeda Manufacturing Company is considering three new projects, each requiring an equipment investment of $22,000. Each project will last for 3 years and produce the following cash inflows.

Year AA BB CC

1 $ 7,000 $ 9,500 $11,000

2 9,000 9,500 10,000

3 15,000 9,500 9,000

Total $31,000 $28,500 $30,000

The equipment's salvage value is zero. Cepeda uses straight-line depreciation. Cepeda will not accept any project with a payback period over 2 years. Cepeda's minimum required rate of return is 12%.

Compute each project paybeck period.

Payback period

Project AA = 2 years 4.8 months

Project BB = 2 years 3.8 months

Project CC = 2 years 1.3 months

Explanation:

Project AA

Cash inflow for after 2 years = 7000 + 9000 = 16000

Balance to recover initial cost = 22,000 - 16000 = 6,000

Payback period

= 2 years + (6000/15000) * 12 months

= 2 years 4.8 months

Project BB

Cash inflow for after 2 years = 9500 + 9500 = 19,000

Balance to recover initial cost = 22,000 - 19000 = 3,000

Payback period

= 2 years + (3000/9,500) * 12 months

= 2 years 3.8 months

Project CC

Cash inflow for after 2 years = 11,000 + 10,000 = 21,000

Balance to recover initial cost = 22,000 - 21,000 = 1,000

Payback period

= 2 years + (1,000/9,000) * 12 months

= 2 years 1.3 months