An investment project that requires a present investment of $210,000 will have cash inflows of "R" dollars each year for the next five years. The project will terminate in five years. Consider the following statements (ignore income tax considerations):
I. If "R" is less than $42,000, the payback period exceeds the life of the project.
II. If "R" is greater than $42,000, the payback period exceeds the life of the project.
III. If "R" equals $42,000, the payback period equals the life of the project.
Which statement(s) is (are) true?

Question

Quizplus · Accepted Answer

The payback period is the time it takes for the initial investment to be recovered through the net cash inflows from the project. If the cash inflows are constant, the payback period is simply the initial investment divided by the annual cash inflow. Therefore, the payback period is 210,000/R.

I. If R is less than $42,000, the payback period exceeds the life of the project. This is true because the payback period is 210,000/R. If R is less than $42,000, then the payback period will be greater than 5 years, the life of the project.

II. If R is greater than $42,000, the payback period exceeds the life of the project. This is false. If R is greater than $42,000, then the payback period will be less than 5 years, the life of the project.

III. If R equals $42,000, the payback period equals the life of the project. This is true because the payback period is 210,000/R, which equals 5 years when R is $42,000.

Therefore, only statement I and III are true, making option B the correct answer.

An Investment Project That Requires a Present Investment of $210,000