A project has the following cash flows over the next 5 years: $800, $300, $400, $900 and $1,200. Assume all cash flows occur at the end of a year. The project requires an initial cash outlay of $1,750. The firm faces a marginal borrowing rate of 8%. The payback period for the project equals ________.
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A. B. C. D.D
The payback period is defined as the expected number of years that would be required to recover the original investment. In particular,
Payback period = Years before full recovery +
(unrecovered cost at the start of payback year)/(net cash flow in the payback year) In this case, the recovery occurs in the 4th year. At the beginning of the 4th year, the unrecovered cost equals 1,750 - 800 - 300 - 400 = 250. Total cash flow in the 4th year equals 900. Therefore, payback period = 3 + 250/900 = 3.28 years. Note that the discount rate does not figure in the calculation of payback period.