Brew Ltd purchases a machine which costs £290,000 immediately. The machine will generate net cash inflows of £205,000 in the first year, £78,000 in year 2, and £60,000 in each of years 3 and 4.  What is the payback period? (Rounded up to the next month)

Question 7 options:

3 years and 1 month

2 years and 1 month

2 years and 2 months

3 years and 2 months

To calculate the payback period, we need to determine how long it takes for the cumulative cash inflows to equal the initial investment of £290,000.

### Cumulative Cash Flows:

1. **Year 1**: £205,000
2. **Year 2**: £205,000 (from Year 1) + £78,000 = £283,000
3. **Year 3**: £283,000 (from Year 2) + £60,000 = £343,000

### Analysis:

- After **Year 1**, the cumulative cash inflow is £205,000.
- After **Year 2**, the cumulative cash inflow is £283,000.
- At the start of **Year 3**, only £7,000 (£290,000 - £283,000) more is needed to recover the initial investment.

### Calculation for Year 3:

- The machine generates £60,000 in Year 3.
- To find out how many months it takes to recover the remaining £7,000:
  \[
  \text{Months in Year 3} = \left(\frac{£7,000}{£60,000}\right) \times 12 = 1.4 \text{ months}
  \]

Since we round up to the next month, the payback period is:

**2 years and 2 months**.

So, the correct answer is:

**2 years and 2 months**.

Do you need any further explanation? Here are some follow-up questions you might consider:

1. How does the payback period impact investment decisions?
2. What are the limitations of using the payback period as a sole metric?
3. How would a delayed cash inflow affect the payback period?
4. What is the difference between the payback period and the net present value?
5. How would the payback period change if there were maintenance costs involved?

**Tip:** The payback period is a simple way to assess how quickly an investment can be recouped, but it's important to consider other factors like profitability and risk.

Learn how to calculate the payback period for an investment of £290,000 with annual cash inflows of £205,000, £78,000, and £60,000 over four years. Understand the method used, including step-by-step calculations and rounding up to the next month. Suitable for professionals in finance and investment analysis.

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