Simple Payback Period (SL IB Business Management)

1. Simple Payback Calculation

Gomez Carpets is considering an investment in a new storage facility at a cost of $200,000. It expects additional net cash flow of $30,000 per year as a result of the investment.

Calculate the Payback period for the investment. [3]

Step 1 - Substitute the values into the formula

    [1 mark]

 

Step 2 - Convert the outcome to years and months

   6 years

   0.67 years     =    8.04 months  [1 mark]

   Payback period    =    6 years and 8 months  [3 marks for the correct answer]

2. Payback calculation for varying cash flow over time

Hammer and Son provides a household repairs service that has recently employed a new handywoman who requires her own van. The new van will be purchased for $32,000

The net cash flows are expected to vary over the five years following its purchase and are shown in the table below.

Year	Net cash Flow ($)	Cumulative Cash Flow ($)
0	(32,000)	(32,000)
1	14,000	(18,000)
2	10,000	(8,000)
3	6,000	(2,000)
4	3,000	1,000
5	2,000	3,000

 

Calculate the payback period for the van. [4]
 

Step 1 - Identify the final year where the cumulative cash flow is negative

   In this case the cumulative cash flow figure is  -$2,000 at the end of Year 3

   This is the remaining amount (outlay) outstanding. [1 mark]
 

Step 2 - Calculate the monthly net cash flow for the next year (year 4)

    $3,000 ÷ 12 (months)       =    $250  [1 mark]
 

Step 3 - Divide the remaining amount outstanding by the monthly net cash flow

    $2000 ÷ $250     =     8 months  [1 mark]
 

Step 4 - Identify the payback period

   In this case the Payback period is 3 years and 8 months  [1 mark]