Question

When evaluating potential projects, the firm has a required payback period of 3 years and a required rate of return of 10%. The project you are analyzing has a payback period of 2.1 years, an internal rate of return of 14% and a NPV of -$840. Should this project be accepted? Show the details calculations.

Answer 1

Payback period is less than the firm’s required payback period.

But we should consider another two important aspects of the project i.e. The NPV and IRR.

Internal Rate of Return of the project is 14 %, which is greater than the required 10 % rate of return of the firm.

Also NPV of – $ 840 is negative. The firm will get a loss of $ 840 on accepting the project.

Only payback period decision supports the project to accept it but payback period disregards the time value of money.

So based on NPV and IRR, the project should be rejected.