Page 504 - F2 - MA Integrated Workbook STUDENT 2018-19

Chapter 18

Chapter 14

Example 1

Company X has a policy of only accepting projects that give a pay back of
four years or less. A machine is available for purchase at a cost of $150,000.
We expect it to have a life of five years and to have a scrap value of $20,000
at the end of the five-year period.

We have estimated that it will generate net cash flows over its life as follows:

$000

1st year 40
2nd year 75

3rd year 60
4th year 30
5th year 10

Step 1 – set up a table with columns for year, cash flow, and cumulative
balance.

Step 2 – put in the figures and calculate the cumulative balance until we get a
positive figure (have paid back the investment).
Year Cash flow Cumulative cash flow
$000 $000
0 (150) (150)
1 40 (110)
2 75 (35)
3 60 25
4 30
5 30

Step 3 – work out what fraction of a year was required in the last year of
payback.

$35,000 ÷ $60,000 × 12 = 7 months or
$60,000 ÷ 12 = $5,000 a month, $35,000 ÷ $5,000 = 7 months
Payback period – 2 years and 7 months therefore accept

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