CHAPTER 8
NET PRESENT VALUE AND OTHER INVESTMENT CRITERIA
Answers to Concepts Review and Critical Thinking Questions
1.
A payback period less than the project’s life means that the NPV is positive for a zero
discount rate, butnothing more definitive can be said. For discount rates greater than zero,
the payback period will stillbe less than the project’s life, but the NPV may be positive,
zero, or negative, depending on whether thediscount rate is less than, equal to, or greater
than the IRR.
2.
If a project has a positive NPV for a certain discount rate, then it will also have a positive
NPV for azero discount rate; thus the payback period must be less than the project life. If
NPV is positive, thenthe present value of future cash inflows is greater than the initial
investment cost; thus PI must begreater than 1. If NPV is positive for a certain discount
rate R, then it will be zero for some largerdiscount rate R*; thus the IRR must be greater
than the required return.
3.
a.
Payback period is simply the breakeven point of a series of cash flows. To actually
compute thepayback period, it is assumed that any cash flow occurring during a given
period is realizedcontinuously throughout the period, and not at a single point in time.
The payback is then the pointin time for the series of cash flows when the initial cash
outlays are fully recovered. Given somepredetermined cutoff for the payback period, the
decision rule is to accept projects that payback before this cutoff, and reject projects that
take longer to payback.
b.
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 Net Present Value, PAYBACK PERIOD

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