You are considering making a movie. The movie is expected to cost $ 10.8 million
ID: 2769470 • Letter: Y
Question
You are considering making a movie. The movie is expected to cost $ 10.8 million up front and take a year to produce. After that, it is expected to make $4.2 million in the year it is released and $ 1.9 million for the following four years. What is the payback period of this investment? If you require a payback period of two years, will you make the movie? Does the movie have positive NPV if the cost of capital is 10.5%? What is the payback period of this investment? The payback period is years.Explanation / Answer
Solution:
Payback period is the length of time within which the initial investment is returned back to the company. Simple payback period does not consider Time Value of Money.
We need to calculate cumulative cash inflow to calculate payback period.
Year
Cash Inflows
Cumulative Cash Inflows
1
$4,200,000
$4,200,000
2
$1,900,000
$6,100,000
3
$1,900,000
$8,000,000
4
$1,900,000
$9,900,000
5
$1,900,000
$11,800,000
Initial Investment = $10,800,000
From the table above it is clear that the initial investment is returned back to the company between 4 & 5 year. Hence the payback period exists between 4 and 5 years.
Upto 4 years company have recovered = $9,900,000
Balance amount of initial investment to be recovered = $900,000 ($10,800,000 - $9,900,000)
In 5th year the earning of the company is $1,900,000
Hence the following equation can be made:
Payback Period = 4 years ($9,900,000 recovered) + balance to be recovered ($900,000) / Cash Inflow of 5th year ($1,900,000)
Payback Period = 4 years + $900,000 / $1,900,000
= 4 years + 0.47 years
= 4.47 years or 4.5 years (rounded off to one decimal)
Year
Cash Inflows
Cumulative Cash Inflows
1
$4,200,000
$4,200,000
2
$1,900,000
$6,100,000
3
$1,900,000
$8,000,000
4
$1,900,000
$9,900,000
5
$1,900,000
$11,800,000
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