CSLB Law & Business ExamBusiness FinancesHard
A contractor is evaluating a potential new project. The project requires an initial investment of $100,000 and is expected to generate net cash inflows of $30,000 per year for five years. What is the payback period for this project?
- A4 years
- B5 years
- C2 years
- D3.33 years
Show answer & explanationAnswer & explanation
Correct answer: D. 3.33 years
The payback period is the time it takes for an investment to generate enough cash flow to cover its initial cost. With consistent annual cash inflows, it's calculated as Initial Investment / Annual Cash Inflow. So, $100,000 / $30,000 = 3.33 years.
Why the other options are wrong
- A. Incorrect calculation.
- B. This is the total project duration, not the payback period.
- C. Incorrect calculation.
Payback Period
A capital budgeting technique that measures the length of time required for an investment to recover its initial cost from the net cash inflows it generates.
- Calculated as Initial Investment / Annual Cash Inflow (for even cash flows).
- A shorter payback period is generally preferred.
- Does not consider the time value of money or cash flows beyond the payback period.
Memory trick: Payback: How long until you get your initial cash back?