Question

Chinook Industries Inc. is evaluating two capital investment proposals for a retail outlet, each requiring an investment of $150,000 and each with an eight-year life and expected total net cash flows of $240,000. Location 1 is expected to provide equal annual net cash flows of $30,000, and Location 2 is expected to have the following unequal annual net cash flows:
Year 1 $59,000
Year 2 44,000
Year 3 29,000
Year 4 18,000
Year 5 31,000
Year 6 25,000
Year 7 18,000
Year 8 16,000
Required:
1. Determine the cash payback period for both location proposals.

Answer 1

Answer:

Location 1: Payback period = 5 years

Location 2: Payback period = 4 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 the initial cost  

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

Payback period =The initial invest /Net cash inflow per year

Location 1 project

Payback period = 150,000/30,000 =   5 years

Payback period = 5 years

Location 2 project

Since the cash inflows are uneven, we accumulate the cash inflows and track when the sum  would equal the initial cost of $150,000.

Cumulative cash in flows= 59,000 + 44,000 + 29,000 + 18,000= 150 ,000

At the end of year 4 the project paid back exactly the sum of $150,000

Payback period = 4 years