Payback Period Practice Questions

Q1. For constructing a machine, the initial cost of investment $15,00,000 and is expected to
generate the following net cashflows during the first six years:
Year 1: $200 000, Year 2: $300 000, Year3 : $400 000, Year 4 : $200 000, Year 5 : 300 000 ,
Year 6 : 300 000 .
Calculate the Payback period of a new machine

Solution :

Years Net Cash Inflow ($) Cumulative Cash Inflow ($)

1 200,000 200,000
2 300,000 500,000 (200,000 + 300,000)
3 400,000 900,000 (500,000 + 400,000)
4 200,000 11,00,000 (900,000 + 200,000)
5 300,000 14,00,000 (11,00,000 + 300,000)
6 300,000 17,00,000 (14,00,000 + 300,000)

Step 1 : Calculate the shortfall

= Cost of Investment – 5th Year Year Cumulative Cash Inflow
= 15,00,000 – 14,00,000
= 100,000

Step 2 : Calculate the average monthly cash inflow

= 6th Year Net Cash Inflow / 12 Months
= 300,000 / 12
= 25,000

Step 3 : Divide (Step 1) by (Step 2) to find the number of months

= 100,000 / 25,000
= 4 Months

Therefore, the payback period for the sports complex Is forecast to be 5 years and 4 month.
Q2. Melannie Bayless has purchased a business building for $330,000. She expects to receive
the following Net Cash Inflows over a 10-year period. Calculate the Payback Period.
Years Net Cash Inflows ($)
1 30,000
2 45,000
3 20,000
4 10,000
5 50,000
6 35,000
7 60,000
8 90,000
9 20,000
10 40,000

Solution :

Years Net Cash Inflow ($) Cumulative Cash Inflow ($)

1 30,000 30,000
2 45,000 75,000 (30,000 + 45,000)
3 20,000 95,000 (75,000 + 20,000)
4 10,000 105,000 (95,000 + 10,000)
5 50,000 155,000 (105,000 + 50,000)
6 35,000 190,000 (155,000 + 35,000)
7 60,000 250,000 (190,000 + 60,000)
8 90,000 340,000 (250,000 + 90,000)
9 20,000 360,000 (340,000 + 20,000)
10 40,000 400,000 (360,000 + 40,000)

Step 1 : Calculate the shortfall

= Cost of Investment – 7th Year Year Cumulative Cash Inflow
= 330,000 – 250,000
= 80,000

Step 2 : Calculate the average monthly cash inflow

= 8th Year Net Cash Inflow / 12 Months
= 90,000 / 12
= 7,500

Step 3 : Divide (Step 1) by (Step 2) to find the number of months

= 80,000 / 7,500
= 10.66 Months
= 10 Months
Therefore, the payback period for the sports complex Is forecast to be 7 years and 10 month.
Q3 : A company requires an initial investment of Rs. 40,000. The estimated Net Cash Inflows
are as follows :
Years Net Cash Inflows ($)
1 7,000
2 7,000
3 7,000
4 7,000
5 7,000
6 8,000
7 10,000
8 15,000
9 10,000
10 4,000

Solution :

Years Net Cash Inflow ($) Cumulative Cash Inflow ($)

1 7,000 7,000
2 7,000 14,000 (7,000 + 7,000)
3 7,000 21,000 (14,000 + 7,000)
4 7,000 28,000 (21,000 + 7,000)
5 7,000 35,000 (28,000 + 7,000)
6 8,000 43,000 (35,000 + 8,000)
7 10,000 53,000 (43,000 + 10,000)
8 15,000 68,000 (53,000 + 15,000)
9 10,000 78,000 (68,000 + 10,000)
10 4,000 82,000 (78,000 + 4,000)

Step 1 : Calculate the shortfall

= Cost of Investment – 5th Year Year Cumulative Cash Inflow
= 40,000 – 35,000
= 5,000

Step 2 : Calculate the average monthly cash inflow

= 6th Year Net Cash Inflow / 12 Months
= 8,000 / 12
= 667

Step 3 : Divide (Step 1) by (Step 2) to find the number of months

= 5,000 / 667
= 7.49 Months
= 7 Months
Therefore, the payback period for the sports complex Is forecast to be 5 years and 7 months.
Q4. Aarya has purchased a business building for $336,000. She expects to receive the following
cash flows over a 10-year period:

Year 1: $42,000
Year 2: $58,800
Years 3-10: $84,000
Solution :

Year Net Cash Inflow Cumulative Cash Inflow

1 $42,000 $42,000

2 $58,800 $100,800

3 $84,000 $184,800

4 $84,000 $268,800

5 $84,000 $352,800

6 $84,000 $436,800

7 $84,000 $520,800

8 $84,000 $604,800

9 $84,000 $688,800

10 $84,000 $772,800

Step 1 : Calculate the shortfall

= Cost of Investment – 4th Year Year Cumulative Cash Inflow
= 336,000 – 268,800
= 67,200

Step 2 : Calculate the average monthly cash inflow

= 5th Year Net Cash Inflow / 12 Months
= 84,000 / 12
= 7000

Step 3 : Divide (Step 1) by (Step 2) to find the number of months

= 67,200 / 7000
= 9.6 Months
= 9 Months
Therefore, the payback period for the sports complex Is forecast to be 4 years and 9 months.
Q5. Company XYZ is considering an investment of $100,000. The useful life of the project is 10 years.
The board of directors has identified two alternatives A and B. The expected annual cash flows are as
follows:

Years Alternative A ($) Alternative B ($)

1 35,000 50,000
2 28,000 40,000
3 32,000 20,000
4 40,000 10,000

Solution
Alternative A

Years Net Cash Inflow ($) Cumulative Cash Inflow ($)

1 35,000 35,000
2 28,000 63,000 (35,000 + 28,000)
3 32,000 95,000 (63,000 + 32,000)
4 40,000 135,000 (95,000 + 40,000)

Step 1 : Calculate the shortfall

= Cost of Investment – 3rd Year Year Cumulative Cash Inflow
= 100,000 – 95,000
= 5,000

Step 2 : Calculate the average monthly cash inflow

= 4th Year Net Cash Inflow / 12 Months
= 40,000 / 12
= 3333

Step 3 : Divide (Step 1) by (Step 2) to find the number of months

= 5,000 / 3,333
= 1.5 Months
= 1 Month

Therefore, the payback period for the sports complex Is forecast to be 3 years and 1 month.
 Alternative B

Years Net Cash Inflow ($) Cumulative Cash Inflow ($)

1 50,000 50,000
2 40,000 90,000 (50,000 + 40,000)
3 20,000 110,000 (90,000 + 20,000)
4 10,000 120,000 (110,000 + 10,000)

Step 1 : Calculate the shortfall

= Cost of Investment – 2nd Year Year Cumulative Cash Inflow
= 100,000 – 90,000
= 10,000

Step 2 : Calculate the average monthly cash inflow

= 3rd Year Net Cash Inflow / 12 Months
= 20,000 / 12
= 1,666

Step 3 : Divide (Step 1) by (Step 2) to find the number of months

= 10,000 / 1,666
= 6 Months

Therefore, the payback period for the sports complex Is forecast to be 2 years and 6 months.