Question

Susan is considering adding toys to her gift shop. She estimates that the cost of inventory will be $6,500. The remodeling expenses and shelving costs are estimated at $2,800. Toy sales are expected to produce net cash inflows of $3,300, $3,300, $4,300, and $4,300 over the next four years, respectively. What is the payback period? (Please round to three decimal places). Should Susan add toys to her store if she assigns a three-year payback period to this project? Why or why not?

Answer 1

Answer:

Payback period= 2 years, 7.53 months

If Susan assigns a 3 year payback period, the toys should  be added.

This is so because, with a 3 year payback period, Susan would expect to recoup her investment within a three year period but the project would actually recoup its cash outflow in less than 3 years.

Since the actual payback period(2 year 7.5 months) is less than the target payback period (3 years), the investment should be undertaken

Explanation:

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

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

The total cost of the investment =6,500+2,800 = 9300

Payback period

Cumulative cash inflow at the end of year two= 3,300+ $3,300= 6600

Balance left to recoup investment = 9,300 - 6,600 = 2,700

Payback period = 2 years + (2700/4300)× 12

                          = 2 years, 7.53 months

If Susan assigns a 3-year payback period, the toys should  be added.

This is so because, with a 3-year payback period, Susan would expect to recoup her investment within a three-year period but the project would actually recoup its cash outflow in less than 3 years.

Since the actual payback period(2 year 7.5 months) is less than the target payback period (3 years), the investment should be undertaken. Because the project would recoup its investment faster than than the stipulated time.

Answer 2

Answer:

2.63 years or 2 years 7.56 months

Explanation:

Payback period is the time in which a project returns back the initial investment in the form of net cash flow.

Initial Investment includes all the expense made on an asset to make it usable.

Initial Investment = $6,500 + $2,800 = $9,300

Year     Balance    Recovery    Time period

  0        ($9,300)          0                  0

  1         ($6,000)      $3,300             1

  2        ($2,700)      $3,300              1

  3         $1,600        $2,700           0.63

Total Period                                   2.63 years

Payaback period = 2 years + 0.63 x 12 months = 2 years 7.56 months