The Payback Method is used to determine the number of periods that must pass before the net after-tax cash inflows from the investment equals (or "pays back") the initial investment cost. We will calculate the cumulative net cash flows to see how long it takes for this investment to pay back the initial investment cost: After-Tax Cumulative Net Years Cash Flows Cash Flows 0 $(20,000) $(20,000) 1 6,000 (14,000) 2 6,000 (8,000) 3 8,000 0 4 8,000 8,000 The payback period of this project will be exactly 3.0 years, because that is when the cumulative net cash flow reaches zero. At that point, the initial investment has been paid back. Usually, payback periods do not work out so evenly, so the formula given in your book is needed. Here we can use the formula, but we don't need to. If we were to use the formula, our calculation would be: 2 + 8,000 / 8,000 = 2 + 1 = 3, or 3.0.
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