Payback Period

This topic has 8 replies, 3 voices, and was last updated 5 years ago by John Moffat.

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November 3, 2016 at 4:05 am #347157
furqan.90
- Topics: 34
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Hi John,

Kindly help me with this question.In your lecture we did not consider depreciation in the payback method.And even if we had to consider depreciation I would have thought it would be deducted from cash inflow rather than being added to it.

Best Regards,
Furqan

Assuming operational cash flows arise evenly over the year, what is the payback period for this investment
(to the nearest month)?
A 1 year 7 months
B 2 years 7 months
C 1 year 5 months
D 3 years 2 months

Payback period is the amount of time taken to repay the initial investment.
Time Profit Depreciation* Cash flow
Cumulative
cash flow
$ $ $ $
0 Investment (46,000) (46,000)
1 Cash inflow 16,500 9,750 26,250 (19,750)
2 Cash inflow 23,500 9,750 33,250 13,500
* Depreciation = ($46,000 – $7,000) / 4
Payback period = 1 + (19,750/33,250) = 1.59 years or 1 year 7 months to the nearest month.
November 3, 2016 at 4:49 am #347158
furqan.90
- Topics: 34
- Replies: 41
NW Co is considering investing $46,000 in a new delivery lorry that will last for four years, after which time it will
be sold for $7,000. Depreciation is charged on a straight-line basis. Forecast operating profits/(losses) to be
generated by the machine are as follows.
Year $
1 16,500
2 23,500
3 13,500
4 (1,500)

sorry forgot to post the additional info in the scenario
November 3, 2016 at 5:39 am #347161
furqan.90
- Topics: 34
- Replies: 41
I think I’ve got it,because payback method is based on inflow and we are given profits in the question so we add the dep to get cash inflow right?
November 7, 2016 at 11:14 pm #347953
Maria
- Topics: 1
- Replies: 3
Hi I was just about to post the same question as I too was confused as to why dep’n was included in the answer but the example given by the lecturer did not mention dep’n !! Still not sure why it is included ?
November 8, 2016 at 8:13 am #348009
John Moffat
Keymaster
- Topics: 57
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Furqan: Correct – the payback period is the number of years it takes to get back the original investment in cash terms. So if you are give profits you need to add back the depreciation to get the cash flow.

Maria: If you are given profits then profits are always calculated after depreciation. Therefore to get the cash flow you need to add back the depreciation.

If necessary you should watch the free Paper F2 lectures on investment appraisal, because payback period is explained there in detail (payback period is not asked often in F9 and is purely revision of F2).
November 8, 2016 at 2:20 pm #348058
Maria
- Topics: 1
- Replies: 3
Many thanks John, it finally clicked last night what had happened. That is were the MCQ are tricky must read the question properly, they will provide you with both answers and under pressure it is so easy to get to the wrong answer. Bring back the old exam format anyday !!
November 8, 2016 at 3:54 pm #348080
John Moffat
Keymaster
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You are welcome 🙂
November 20, 2016 at 8:34 am #350123
furqan.90
- Topics: 34
- Replies: 41
Thanks John.
November 20, 2016 at 3:42 pm #350160
John Moffat
Keymaster
- Topics: 57
- Replies: 50627
You are welcome also 🙂
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