# Payback period, NPV, IRR

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Strategic decision makers are required to be able to evaluate projects based on the long-term objectives of the firm as well as the project's ability to earn the company additional compensation. The 3 main tools used to make this evaluation are the pay-back period, net present value (NPV), and internal rate of return (IRR).

Year Project #1 Project #2 Project #3

0 ($30,000) ($32,000) ($35,000)

1 $11,000 $15,000 $11,000

2 $11,000 $14,000 $11,000

3 $11,000 $11,000 $11,000

4 $11,000 $2,000 $11,000

5 $11,000 $500 $11,000

Scenario NPV Rate

1 5%

2 5.5%

3 6%

Using the data in the tables above, answer the following questions:

- Calculate the NPV for each project using each scenario's NPV rate. Show your work.

- Calculate the pay-back period for each project. Show your work.

- Calculate the IRR for each project. Show your work.

- Which project would the company select using the NPV method in scenario 1? Explain your answer.

- Which project would the company select using the NPV method in scenario 2? Explain your answer.

- Which project would the company select using the NPV method in scenario 3? Explain your answer.

- Which project would the company select using the pay-back period? Explain your answer.

- Which project would the company select using the IRR method? Explain your answer.

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##### Solution Summary

Strategic decision makers are required to be able to evaluate projects based on the long-term objectives of the firm as well as the project's ability to earn the company additional compensation. The 3 main tools used to make this evaluation are the pay-back period, net present value (NPV), and internal rate of return (IRR).

Year Project #1 Project #2 Project #3

0 ($30,000) ($32,000) ($35,000)

1 $11,000 $15,000 $11,000

2 $11,000 $14,000 $11,000

3 $11,000 $11,000 $11,000

4 $11,000 $2,000 $11,000

5 $11,000 $500 $11,000

Scenario NPV Rate

1 5%

2 5.5%

3 6%

Using the data in the tables above, answer the following questions:

- Calculate the NPV for each project using each scenario's NPV rate. Show your work.

- Calculate the pay-back period for each project. Show your work.

- Calculate the IRR for each project. Show your work.

- Which project would the company select using the NPV method in scenario 1? Explain your answer.

- Which project would the company select using the NPV method in scenario 2? Explain your answer.

- Which project would the company select using the NPV method in scenario 3? Explain your answer.

- Which project would the company select using the pay-back period? Explain your answer.

- Which project would the company select using the IRR method? Explain your answer.

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