17. You have conducted a capital budgeting analysis of projects A, B and C with the following results: NPV IRR Payback A 200,000 8.7% 4 years B -100,000 5.6% 3 years C 300,000 9.8% 5 years If r=7% and the company has set the payback cutoff at 3 years, which is false? (a) Each project is acceptable under at least one method (b) The IRR and NPV would lead to different acceptance decisions on at least one project (c) The payback period focuses on speed of payback instead of the best financial decision (d) Based on best practices for capital budgeting discussed in class, A and C should be accepted
why A is true and B is false??
17. You have conducted a capital budgeting analysis of projects A, B and C with the following results: NPV IRR Payback A 200,000 8.7% 4 years B -100,000 5.6% 3 years C 300,000 9.8% 5 years If r=7% and the company has set the payback cutoff at 3 years, which is false? (a) Each project is acceptable under at least one method (b) The IRR and NPV would lead to different acceptance decisions on at least one project (c) The payback period focuses on speed of payback instead of the best financial decision (d) Based on best practices for capital budgeting discussed in class, A and C should be accepted
why A is true and B is false??
Related questions
Capital budgeting involves choosing projects that add value to the firm. The net present value (NPV), internal rate of return (IRR) and payback period methods are the most common approaches to project selection. At its core, capital budgeting is measuring an accounting of costs versus benefits. In a way, all business decisions are a series of capital budgeting decisions. Get it wrong, and you can destroy a company.
The capital budgeting tools help financial managers decide on the desirability of the projects. In the real world, however, managers sometimes will make decisions that don't necessarily agree with the decision rules of the payback period, NPV or IRR methods.
For example, consider the two mutually exclusive projects below.
| Investments | Cost | Cash Flow 1 | Cash Flow 2 |
| Project A | $ 50 | $ - | $ 100 |
| Project B | $ 50 | $ 50 | $ 25 |
According to the payback period, project B should be selected. Although both projects cost the same, project B has a payback period of one period, while project A will payback in roughly 1.5 periods.
Assuming the discount rate of 5%, NPV(A) = $41 and NPV(B) = $20.
This example illustrates the limitations of the payback period method. Even though the payback period method points to project B, the NPV method points to project A since it has more than twice the NPV value to that of project B. Yet the manager may choose project A. Why?
It may be that the project stakeholder is requesting a quicker return in cash.
For this discussion, create an example problem where two (or more) methods contradict each other. What would be the "appropriate" choice (which project would you choose)? In what cases would you not choose the "best" choice?
