Question 19.1: The payback method Miln Limited is considering investing in ...
The payback method
Miln Limited is considering investing in some new machinery. The following information has been prepared to support the project:
| £000 | £000 | |
| Cost of machinery | 20 | |
| Expected net cash flow: | ||
| Year 1 | 1 | |
| 2 | 4 | |
| 3 | 5 | |
| 4 | 10 | |
| 5 | \underline{10} | \underline{30} |
| Net profitability | \underline{\underline{10} } |
Required:
Calculate the prospective investment’s payback period.
The payback period is as follows:
| £000 | ||
| Cumulative net cash flow: | ||
| Year 1 | 1 | |
| 2 | (£1 000 + £4 000) | 5 |
| 3 | (£5 000 + £5 000) | 10 |
| 4 | (£10 000 + £10 000) | 20 |
| 5 | (£20 000 + £10 000) | 30 |
The investment will, therefore, have paid for itself at the end of the fourth year. At that stage £20,000 will have been received back from the project in terms of net cash flow and that sum would be equal to the original cost of the project.
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