Question

ANSWER B. IS NOT CORRECT. I LEFT IT IN BECAUSE TECHNICALLY ANSWER D., WHICH INCLUDES ANSWER B., COULD BE CORRECT.

Marshall is considering two investments. Investment Y will cost $15,000 and will result in increased profits of $5,000 in Year 1; $7,000 in Year 2; and $10,000 in Year 3, with no additional profits beyond Year 3. Investment Z will also cost $15,000, but will result in additional profits of $10,000 in Year 1; $7,000 in Year 2; and $5,000 in Year 3, with no additional profits beyond Year 3. WITHOUT doing any calculations, which statement(s) below is(are) true?

A. Investment Y has a higher NPV than Investment Z because more of the additional profits are earned in a shorter period of time.

B. Investment Z will have the shorter payback period.

C. Investments Y and Z will have the same NPV because the costs are the same and the totals of the future payments are the same.

D. Both A and B are correct.

E. Both B and C are correct.

AGAIN, ANSWER B. IS NOT CORRECT. I LEFT IT IN BECAUSE TECHNICALLY ANSWER D., WHICH INCLUDES ANSWER B., COULD BE CORRECT.

Answer 1

Investment Z will recover the initial cost i.e. $15000 in 2nd year only whereas investment Y will recover the cost in the 3rd year.

Hence, Investment Z has shorter payback period.

Option B is correct.

Also, investment Z has higher cash inflow in the early years whereas investment Y has higher cash inflow in the late years. Hence, if you discount with the required rate of return to get present value of the cash flows, investment Z will have higher present value or NPV than investment Y. Hence, investment Z has higher NPV than investment Y.

Hence, option A and C is not correct. Likewise, option D and E is also not correct.

Hence, only option B is correct.