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IAI Actuarial Core Principles · Business Finance · Cost of capital and evaluating investment projects

Mehta Textiles is considering a machine costing Rs 10,00,000. Expected net cash inflows are Rs 3,00,000 in year 1, Rs 4,00,000 in year 2, Rs 5,00,000 in year 3 and Rs 2,00,000 in year 4, received evenly through each year. What is the simple payback period?

Payback is 2.6 years. Cumulative cash inflows reach Rs 7,00,000 after two years, leaving Rs 3,00,000 to recover. Year 3 produces Rs 5,00,000 evenly, so 0.6 of that year is needed, giving 2 plus 0.6 equals 2.6 years.

  1. A2.40 years
  2. B2.60 years
  3. C2.80 yearsCorrect
  4. D3.00 years
  5. 3.50 years

Explanation

Cumulative inflows are 3,00,000 after year 1 and 7,00,000 after year 2. The remaining Rs 3,00,000 is recovered in year 3 at 5,00,000 per year, which is 0.6 of a year. Payback is 2.6 years. Using 3.00 years would be wrong because it waits for the end of year 3 instead of interpolating.

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