Answer:
Option b: 5.2 Years
Explanation:
Payback period is defined as the amount of time it takes for cash returns or cash inflows of a project to recover the initial investment required for the project.
Payback period is estimated using the cumulative cashflows. Beginning from the initial investment, deduct annual cash flows of each successive year until the cumulative cashflow turn positive.
Cashflow Cumulative Cashflow
Year 0 ($180,000) ($180,000)
Year 1 $40,000 ($140,000)
Year 2 $40,000 ($100,000)
Year 3 $40,000 ($60,000)
Year 4 $25,000 ($35,000)
Year 5 $25,000 ($10,000)
Year 6 $50,000 $40,000
Year 7 $50,000 $90,000
Year 8 $50,000 $140,000
*Figures in brackets show negative cashflows
From the table above, it can be observed that the cumulative cashflow turn positive after year 5, which means that the payback period for the project will be somewhere between year 5 and year 6. Therefore, assuming a constant rate of cash inflows during the year, payback period for the project can be computed as
Payback period = 5 Years + (10,000/50,000) Years
Payback Period = 5.2 Years
