The initial outlay or cost for a four-year project is $1,000,000. The

The initial outlay or cost for a four-year project is $1,000,000. The respective cash inflows for years 1, 2, 3 and 4 are: $500,000, $300,000, $300,000 and $300,000. What is the discounted payback period if the discount rate is 10%?

A) About 2.67 years
B) About 3.35 years
C) About 3.67 years
D) About 4.50 years

ANSWER

Answer: B
Explanation: B) We first discount all after-tax cash inflows, which gives us after-tax cash inflows of $454,545.45, $247,933.88, $225,394.44 and $204,904.04. After three years, we will have paid back $927,873.77 leaving $72,126.23 to pay back in after-tax cash flows in the fourth year. Since we get $204,904.04 in the fourth year, the rule of thumb is to divide what is needed by the cash inflows we will get next period and add it to the number of previous periods of cash inflows, e.g., ($72,126.23 divided by $204,904.04) + 3. Doing this gives 3.352. Thus, the payback period is about 3.35 years.