Choice "A" is correct. The payback period is computed as the number of years required to fully recover the original investment with out respect to the time value of money. With uneven cash flows, the payback period is computed by development of a cumulative payback balance converted to years as follows:
| Cash
Inflow
| | Year
Required
| | Adjusted
Cash Inflow
| Cumulative
Cash Inflow
|
|---|
Year 1 | $200 | × | 1.0 | = | $200 | $200 |
Year 2 | $200 | × | 1.0 | = | $200 | $400 |
Year 3 | $400 | × | 1.0 | = | $400 | $800 |
Year 4 | $400 | × | 0.5 | = | $200 | $1,000 |
Payback period | | | 3.5 | | | |
Choice "c" is incorrect. Although the payback occurs in the fourth year, only half the year is required. The payback period is 3.5, not 4.0 years.
Choice "d" is incorrect. Although the payback occurs in the fourth year, half the year is required. The payback period is 3.5, not 3.4 years.
Choice "b" is incorrect. The payback occurs in the fourth year. The payback period is 3.5, not 3.0 years.
