Question 8.P.9: Determine the payback period (PBP) for the cash flows of (a)......
Determine the payback period (PBP) for the cash flows of (a) Problem 8.5, (b) Problem 8.8. (c) Comment on the results in the light of the corresponding ROR-values.
Step-by-Step
(a) PBP = \frac{\$50 000}{\$16719 \text{per year}} = 2.99 years
(b) We have CF_1 + CF_2 = $29 000, CF_1+ CF_2 + CF_3 = $59 000; hence,
PBP ≈ 2 + \frac{\$50 000 – \$29 000}{\$59 000 – \$29 000} (3 – 2) = 2.7 years
(c) The cash flows of Problem 8.5 have a longer payback period, but a higher rate of return, than those of Problem 8.8. We might say that the PBP and the ROR give opposite rankings of the two investments. However, we must always bear in mind that the PBP takes no account of interest.
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