Cash Flow and Payback

K&J Enterprise Inc. has purchased a small motor engine line to go in golf carts. The total purchase
cost was $1.5 million, which can generate revenues of $650,000 per year. Direct manufacturing costs
are expected to run $220,000 a year and other fixed cost expenditures would be somewhere near
$80,000 a year. The O&M cost would be around $45,000 a year, and K&J expects to pay various
taxes including income taxes of $58,000. The project would last about 10 years and at that time, the
business could be sold for $1 million. Determine the project cash flows over a 10-year period. When
does payback occur (approximately)? Use units in thousands of dollars: $650,000 = 650K

n 0 1 2 3 4 5 6 7 8 9 10
Inflow

Outflow

Net Cash
Flow

Consider the following cash flows, for four different projects: (a) Calculate the conventional
payback period for each project. (b) Determine whether it is meaningful to calculate a payback period
for Project D. (c) Assuming i = 10% calculate the discounted-payback period for each project.

A B C D
Conventional
Payback
Discounted
Payback

SOLUTION
K&J Enterprise Inc. has purchased a small motor engine line to go in golf carts. The total
purchase cost was $1.5 million, which can generate revenues of $650,000 per year. Direct
manufacturing costs are expected to run $220,000 a year and other fixed cost expenditures
would be somewhere near $80,000 a year. The O&M cost would be around $45,000 a year,
and K&J expects to pay various taxes including income taxes of $58,000. The project would
last about 10 years and at that time, the business could be sold for $1 million. Determine the
project cash flows over a 10-year period

n Inflow Outflow Net Cash Flow

0 $0 $1,500,000 -$1,500,000
1 $650,000 $403,000 $247,000
2 $650,000 $403,000 $247,000
3 $650,000 $403,000 $247,000
… … … …
8 $650,000 $403,000 $247,000
9 $650,000 $403,000 $247,000
10 $1,650,000 $403,000 $1,247,000

Payback approximately end of year 6.

Consider the following cash flows, for four different projects: (a) Calculate the conventional
payback period for each project. (b) Determine whether it is meaningful to calculate a payback period
for Project D. (c) Assuming i = 10% calculate the discounted-payback period for each project.

n A B C D
CF CumCF CF CumCF CF CumCF CF CumCF

0 -2500 -2500 -6000 -6000 -13000 -13000 -14500 -14500

1 600 -1900 2500 -3500 3000 -10000 6000 -8500
2 500 -1400 1000 -2500 4000 -6000 9000 500
3 500 -900 1500 -1000 5000 -1000 -4000 -3500
4 700 -200 500 -500 6000 5000 5000 1500
5 800 600 500 0 7000 12000 1000 2500
6 400 1000 150 150 2000 4500
7 400 1400 3000 7500
8 400 1800

n A B C D
CF CumCF CF CumCF CF CumCF CF

0 -2500 -2,500 -6000 -6,000 -13000 -13,000 -14500

1 600 -250 -2,150 2500 -600 -4,100 3000 -1,300 -11,300 6000
2 500 -215 -1,865 1000 -410 -3,510 4000 -1,130 -8,430 9000
3 500 -187 -1,552 1500 -351 -2,361 5000 -843 -4,273 -4000
4 700 -155 -1,007 500 -236 -2,097 6000 -427 1,300 5000
5 800 -101 -307 500 -210 -1,807 7000 130 8,430 1000
6 400 -31 62 150 -181 -1,837 2000
7 400 6 468 3000
8 400 47 915
5.9) [older version of problem]
(a) Payback period
Project A: 5 years, Project B: 5 years, Project C: 4 years

A B C D
n CF Cum.CF CF Cum.CF CF Cum.CF CF Cum.CF
0 -$1,500 -$1,500 -$6,000 -$6,000 -$10,000 -$10,000 -$4,500 -$4,500
1 200 -1,300 2,000 -4,000 2,000 -8,000 5,000 500
2 300 -1,000 1,500 -2,500 2,000 -6,000 3,000 3,500
3 400 -600 1,500 -1,000 2,000 -4,000 -4,000 -500
4 500 -100 500 -500 5,000 1,000 1,000 500
5 300 200 500 0 5,000 6,000 1,000 1,500
6 300 500 1,500 1,500 2,000 3,500
7 300 800 3,000 6,500
8 300 1,100

(b) Project D does not have a unique payback period, as there are two payback periods—
one at year 2 and the other at period 4. However, if the project is undertaken, we would
say 4 years, because that is when the project truly is financially in the clear.

(c) Discounted payback period

Project A: 7 years, Project B: none, Project C: 5 years.

A B C D
n CF Cum.CF CF Cum.CF CF Cum.CF CF Cum.CF
0 -$1,500 -$1,500 -$6,000 -$6,000 -$10,000 -$10,000 -$4,500 -$4,500
1 200 -1,450 2,000 -4,600 2,000 -9,000 5,000 50
2 300 -1,295 1,500 -3,560 2,000 -7,900 3,000 3,055
3 400 -1,025 1,500 -2,416 2,000 -6,690 -4,000 -640
4 500 -627 500 -2,158 5,000 -2,359 1,000 297
5 300 -390 500 -1,873 5,000 2,405 1,000 1,326
6 300 -129 1,500 -561 2,000 3,459
7 300 159 3,000 6,805
8 300 474