- This topic has 3 replies, 2 voices, and was last updated 1 year ago by
.
- Posts
Hello!
I was doing a question test that says the following:
Berry Co is considering investing in a six year project which will cost $180,000. The estimated net cash flows are $45,000 per year. Depreciation of $15,000 per year has been included in the cash flow amount.
Calculate the payback period for the project.6 years
4 years
5 years
3 yearsSo, what I did was substract the 15k of depreciation since it is not a cashflow, and it gave me, 6 years, But the solutions says:
Correct Answer
3 years
Depreciation is not a cash flow item, so this should be added back to give a cash flow of (45,000 + 15,000) = $60,000
Payback = (180,000/60,000) = 3 years
Does this make any sense? Thank you!
The answer is correct.
It is because the wording of the question is very poor. When it says that depreciation has been included, it is meaning that in arriving at the 45,000 per year they have including a charge for deprecation and therefore the 45,000 is after charging depreciation. Given that depreciation is not a cash flow it does need adding back.
The main reason why it is a poorly worded question is that because of the above the 45,000 is not the net cash flow. Questions in the real exam will be worded better than this 🙂
- The topic ‘Payback and cashflow question’ is closed to new replies.