Capital Investments and Capital Allocation: practice question

Corporate Issuers · Capital Investments and Capital Allocation · Question ID ci1-10

Cardera Foods invests $120,000 in a new packaging line expected to produce net cash flows of $40,000 in Year 1, $50,000 in Year 2, and $60,000 in Year 3. The project's payback period is closest to:

2.0 years
2.5 years
3.0 years

Show answer and explanation

Correct answer: B

Working: Cumulative cash flow: $40,000 after Year 1 and $90,000 after Year 2, leaving $30,000 of the $120,000 outlay to recover from Year 3's $60,000. Payback = 2 + 30,000 / 60,000 = 2.5 years.

Explanation: The outlay is recovered when cumulative inflows reach $120,000: after two years only $90,000 has come in, and the remaining $30,000 is half of Year 3's $60,000, giving 2.5 years. 2.0 years stops at the $90,000 cumulative total before full recovery, and 3.0 years counts all of Year 3 even though only half of its cash flow is needed.

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Capital Investments and Capital Allocation: practice question

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