Question

Question 8A firm may choose a project with a rapid payback period rather than one with a larger net present value. Discussthe validity of this statement. (2points)

Question 9The internal rate of return represents the rate of interest that recovers the initial investment outlay.Discussthe validity of this statement. (3points)

Question 10In the face of the global financial crisis,Kevin Rudd introduced government guarantees on deposits. Discuss covering at least the followingtwoparts:

1.An introduction/summaryof the Government Guarantee.

2.Thegeneralimpact of this policy to the efficient frontierbased on the Australianenvironment.

Answer 1

Payback method helps in revealing the payback period of an investment. Payback period (PBP) is the time (number of years) it takes for the cash flows of incomes from a particular project to cover the initial investment. When a CFO faces a choice, he will prefer the project with the shortest payback period.

For instance, if the total cost of two projects – A and B – is $12,000 each. But, the cash flows of income of both the projects generate each year are $3,000 and $4000, respectively. The payback period for the project A is four years, while for project B is three years. In this case, project B has the shortest payback period.

Scenarios where firm may choose a project with a rapid payback period rather than one with a larger net present value are :

1. Preference for Liquidity

The payback period is crucial information that no other capital budgeting method reveals. Usually, a project with a shorter payback period also has a lower risk. Such information is extremely crucial for small businesses with limited resources. Small businesses need to quickly recover their cost so as to reinvest it in other opportunities.

2. Useful in Case of Uncertainty

The payback method is very useful in the industries that are uncertain or witness rapid technological changes. Such uncertainty makes it difficult to project the future annual cash inflows. Thus, using and undertaking projects with short PBP helps in reducing the chances of a loss through obsolescence