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# The length of a payback period

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A company with \$2,000,000 in operating assets is considering purchasing a machine that costs \$300,000 and which is expected to reduce operating costs by \$60,000 each year. The payback period for this machine in years is closest to ______?

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This solution helps calculate the length of a payback period.

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## Capital Budgeting: NPV, Payback, IRR, Cash Conversion Cycle, Working Capital

See Attachment.

NPV
Which of the following statements is CORRECT? Assume that the project being considered has normal cash flows, with one outflow followed by a series of inflows.

a. A project's NPV is found by compounding the cash inflows at the IRR to find the terminal value (TV), then discounting the TV at the WACC.
b. The lower the WACC used to calculate it, the lower the calculated NPV will be.
c. If a project's NPV is less than zero, then its IRR must be less than the WACC.
d. If a project's NPV is greater than zero, then its IRR must be less than zero.
e. The NPV of a relatively low risk project should be found using a relatively high WACC.

Payback
Which of the following statements is CORRECT? Assume that the project being considered has normal cash flows, with one outflow followed by a series of inflows.

a. The longer a project's payback period, the more desirable the project is normally considered to be by this criterion.
b. One drawback of the payback criterion for evaluating projects is that this method does not properly account for the time value of money.
c. If a project's payback is positive, then the project should be rejected because it must have a negative NPV.
d. The regular payback ignores cash flows beyond the payback period, but the discounted payback method overcomes this problem.
e. If a company uses the same requirement to evaluate all projects, say it requires a payback of 4 years or less, then the company will tend to reject projects with relatively short lives and accept long-lived projects, and this will cause its risk to increase over time.

Payback
. Which of the following statements is CORRECT? Assume that the project being considered has normal cash flows, with one outflow followed by a series of inflows.

a. The shorter a project's payback period, the less desirable the project is normally considered to be by this criterion.
b. One drawback of the payback criterion for evaluating projects is that this method does not take account of cash flows beyond the payback period.
c. If a project's payback is positive, then the project should be accepted because it must have a positive NPV.
d. The regular payback ignores cash flows beyond the payback period, but the discounted payback method overcomes this problem.
e. One drawback of the discounted payback is that this method does not consider the time value of money, while the regular payback overcomes this drawback.

IRR
Which of the following statements is CORRECT? Assume that the project being considered has normal cash flows, with one outflow followed by a series of inflows.

a. A project's regular IRR is found by compounding the cash inflows at the WACC to find the terminal value (TV), then discounting this TV at the WACC.
b. A project's regular IRR is found by discounting the cash inflows at the WACC to find the present value (PV), then compounding this PV to find the IRR.
c. If a project's IRR is greater than the WACC, then its NPV must be negative.
d. To find a project's IRR, we must solve for the discount rate that causes the PV of the inflows to equal the PV of the project's costs.
e. To find a project's IRR, we must find a discount rate that is equal to the WACC.

Cash Conversion Cycle
. Which of the following statement is CORRECT?

a. Other things held constant, it is better to have a relatively short than a relatively long cash conversion cycle.
b. Other things held constant, it is better to have a relatively short than a relatively long cash conversion cycle.
c. Other things held constant, the length of the cash conversion cycle has no effect on a firm's profitability.
d. Other things held constant, the length of the cash conversion cycle might have an effect on a firm's profitability, but it is impossible to state if that effect is positive or negative.
e. Since firms have no control over their cash conversion cycles, there is little point in studying these cycles.

Working capital
. Other things held constant, which of the following would lead to an increase in working capital?

a. Cash is used to buy marketable securities.
b. A cash dividend is declared and paid.
c. Missing inventory is written off against retained earnings.
d. Long-term bonds are retired from the proceeds of a preferred stock issue.
e. Merchandise is sold on credit, but at a profit.

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