Question

A Company is considering new projects that complement its existing business. The following table summarizes the initial investments(II), the first three years’cash flows(CF), net present values (NPV) and internal rate of returns (IRR) for several capital investment projects.
Project	II	CF1	CF2	CF3	NPV	IRR
A	$100	$20	$20	$20	$50	16%
B	$200	$20	$40	$20	$80	14%
C	$50	$15	$30	$20	$35	35%

Suppose A Company accepts all projects with payback periods less than 3 years. State which project(s) the company should undertake based on this policy and determine the total NPV from following this policy.

Answer 1

Payback period is the time in which the initial investment of the project is recovered by the cashflows generated by the project.

Total CF generated by Project A in first 3 years = 20 + 20 + 20 = 60.
Total Initial Investment was 100, so payback period is certainly more than 3 years.
Hence this project is rejected.

Total CF generated by Project B in first 3 years = 20 + 40 + 20 = 80.
Total initial investment was 200, so payback period of this project is also more than 3 years.
Hence, this project is also rejected.

Total CF generated by Project C in 1 year = 15
Total CF generated by Project C in 2 years = 15 + 30 = 45
Total CF generated by Project C in 3 years = 15 + 30 + 20 = 65
Total initial investment was = 50
So Payback period is greater than 2 years(as only $45 has been generated compared to required $50), but is certainly less than 3 years as $65 generated in 3 years is more than initial investment of $50.
Hence, project C is selected.

As we have not been provide CF during the life time of project C as well as the discount rates, we can not calculate NPV ourselves. But as mentioned in the question NPV of this project is $35.