Question

Which of the following is true about using discounted payback analysis for projects which have only positive cash flows after the initial outlay and for which the discount rate is positive?

a. Discounted payback is better than simple payback because in simple payback analysis the cutoff payback period is arbitrarily set by management.
b. Any project that fails to pay back at all on a discounted basis must have a positive NPV.
c. Discounted payback is much simpler to calculate than regular payback.
d. When comparing two projects, the one with shorter payback period on a discounted basis will have a smaller NPV.
e. The discounted payback period will be longer than the regular payback period.

Answer 1

The correct answer to the student's question is e. The discounted payback period will be longer than the regular payback period, as it accounts for the time value of money by discounting future cash flows.

Step-by-step explanation:

The student has asked what is true about using discounted payback analysis for projects with only positive cash flows after the initial outlay and a positive discount rate. The correct answer to this question is e. The discounted payback period will be longer than the regular payback period because the future cash flows are discounted to their present value, making the payback period appear longer. Answer b is incorrect because a project can fail to pay back on a discounted basis and still have a negative NPV, while d is incorrect because a shorter discounted payback does not necessarily mean a smaller NPV. Discounted payback is also not simpler to calculate than regular payback, which invalidates option c. Lastly, while the cutoff period for simple payback is indeed set by management, this fact alone does not justify why discounted payback is better, making option a incorrect as well.