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Business valuations and market efficiency

Question 5

Payback

A project requires an initial investment of $1,000,000 and then earns net cash
inflows as follows:

Year 1 2 3 4 5 6

Cash inflows ($000) 400 250 200 175 75 50

In addition, at the end of the six year project the assets initially purchased will
be sold for $200,000.

Determine the projects’ payback period.

Calculate cumulative cash flows:

Year cash flow $000 Cumulative cash flow

0 (1,000) (1,000)
1 400 (600)
2 250 (350)
3 200 (150)
4 175 25
5 75
6 250

Payback period = 3 years + 150/175 × 12 months

= 3 years and 11 months (always round up the months)

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