Question

Which of the following decision model does not take into account of the time value of money?

		Discounted Payback Period
		Net Present Value
		Profitability Index
		Payback period

A project is rejected if its NPV < 0.

True

False

Which of the following decision model takes into account of all the cash flows of a project.

		Payback period
		Discounted payback period
		Profitability index
		None

If the Profitability Index (PI) of an investment is 0.7, then that investment will be accepted.

True

False

Answer 1

Payback Period : Payback period refers to the time period taken to recover the initial cost of Investment.

Discounted Payback Period : It refers to the time period taken to recover the initial cost of investment after taking into account the time value of money

Net Present Value : It is the Present Value of all futures Cash flows (i.e. Cash Inflows and Cash Outflows) over the life of investment i.e. After taking into account the time value of money.

Profitability Index : It measures the ratio between present value of future Cash flows and initial investment. It is the ratio of present value of Cash inflows to present value of Cash Outflows.


a) Which of the following decision model does not take into account of the time value of money?
Ans : Payback Period.
Except for Payback period all other 3 decision models i.e. Discounted Payback Period, Net Present Value and Profitablility Index take into account the time value of money.

b) A project is rejected if its NPV < 0.
Ans : True
When NPV is < 0 it means the present value of cash inflows of a project is less than the present value of cash outflows. It means an investor is paying more than what the project is worth.

c) Which of the following decision model takes into account of all the cash flows of a project.
Ans : Profitability Index
Profitability index decision model takes into account all the cash flows of a Project whereas Payback Period and Discounted Payback Period decision model does not take into account the Cash flows post recovery of initial cost of investment.

d) If the Profitability Index (PI) of an investment is 0.7, then that investment will be accepted.
Ans : False
If the Profitability index is greater than 1, the project generates value and thus the investment will be accepted. However if the Profitablity Index is less than 1, the investment will be rejected because the present value cash outflows outweighs the present value of cash inflows.