Choose the correct answer

2. Pay Back Period is the period of time required for the cumulative expected cash flows from an investment project to equal the initial cash outflow. Given below are certain features of capital budgeting methods . Identify which of the following applies to Pay Back period

It reflects a rate of return in which NPV is zero.

It considers all cash inflows of the project.

It applies annuity factor to outweigh different useful life of competing project

It does not take into account time value of money and also does not consider entire cash inflows during the project life.

3. Electric Works Inc. has set 4 years of pay back period as capital investment criteria. It has been considering Projects A and B having following cash flows from investment perspective ( Figures in $ Million):

A B

Initial Investment 1000 1000

Cash Inflows :

Year 1 300 100

Year 2 400 500

Year 3 300 200

Year 4 200 200

Year 5-10 200 500

The company accordingly selected Project A. What mistakes did the company commit by this decision? Select most appropriate alternative.

Pay back period is easy to apply . The company has selected Project A which has lower pay back peeriod.No mistake has been committed.

Short pay back period is always preferred.

The company should have used IRR

Cash flows over the project life are not taken into account and also time value of money has been ignored.

4. A company has been evaluating two investment projects - A & B. Cash flows of the projects are as follows ( Figures in $ Million).

	Project A	Project B
Initial Cash investment	-1000	-1000
Cash Inflows : Year 1	150	50
Years 2-5	170	190
Years 6-10	185	220

Weighted average cost of capital of the company is 11.5%

Applying IRR which of the two projects should the company select ? There is adequate fund available to invest in both the projects. The projects are independent. Under IRR method, a project is accepted if its IRR is higher than or equal to cost of capital.

Project A

Project B

Both Project A & B

None of Project A & B