Chapter 5, Problem 1CQ

Payback Period and Net Present Value If a project with conventional cash flows has a payback period Jess than the project’s life, can you definitively state the algebraic sign of the NPV? Why or why not? If you know that the discounted payback period is less than the project's life, what can you say about the NPV? Explain.

Summary Introduction

To explain: Algebraic sign of NPV and if discounted payback period is less than the project life, then the effect of it on NPV.

Net Present Value (NPV):

Net present value refers to the present value of all the future cash flows that are adjusted according to the time value of money.

Answer to Problem 1CQ

Algebraic sign of NPV is positive in both cases.

Explanation of Solution

When a payback period is smaller than the life of a project, then the net present value (NPV) will be positive. It is because the company will be earning even after they earned back their investment; likewise, in discounted payback period too.

In certain cases where cost of capital is high, it will reduce NPV and make it negative. However, it does not apply in the current situation.

Conclusion

Hence, the sign of NPV in both cases will be positive.