Question

Rossiter Restaurants is evaluating several new projects. Applying the discounted payback decision rule to all projects may cause:

A) some positive net present value projects to be rejected

B) some projects to be accepted which would otherwise be rejected under the payback rule

C) Projects to be incorrectly accepted due to ignoring the time value of money

D) The most liquid projects to be rejected in favor of less liquid projects.

E) a firm to become more long-term focused.

Answer 1

The correct answer is option "A"

Discounted Payback Period and NPV can give conflicting results.

If one project has a Shorter Discounted Payback Period than another and that project is accepted, but just after the breakeven year, if that project has a huge inflow of cash, then the firm is losing it. So this will be captured in the NPV, but the Discounted Payback period only calculates till the breakeven, it ignores the potential huge inflows after the breakeven.

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