Answer (C) is correct . The payback period is the number of years required to complete the return of the original investment. The principal problems with the payback method are that it does not consider the time value of money and the inflows after the payback period. The inflow for the first year is $120,000, the second year is $60,000, and the third year is $40,000, a total of $220,000. Given an initial investment of $200,000, the payback period must be between 2 and 3 years. If the cash inflows occur evenly throughout the year, $20,000 ($200,000 – $120,000 – $60,000) of cash inflows are needed in year 3, which is 50% of that year’s total. Thus, the answer is 2.5 years.
Answer (A) is incorrect because This number of years assumes that the inflows of the first year continue at the same rate in the second year.
Answer (B) is incorrect because The amount of $296,400 will be recovered after 4.91 years.
Answer (D) is incorrect because Less than $180,000 will be paid back after 1.96 years.
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Assuming that the estimated cash inflows occur evenly during each year, the payback period for the investment is