Investment appraisal practice questions.

A machine costs 60000 and generates constant net cash inflows of 15000 per year. Calculate the payback period.

• 3 years
• 4 years
• 0.25 years
• 45000 years

Answer: 4 years

Payback period = initial cost ÷ annual net cash inflow = 60000 ÷ 15000 = 4 years.

An investment costs 120000 and produces total net cash inflows of 240000 over 5 years. Calculate the Average Rate of Return (ARR).

• 40%
• 20%
• 100%
• 24%

Answer: 20%

Average annual profit = (240000 − 120000) ÷ 5 = 24000; ARR = 24000 ÷ 120000 × 100 = 20%.

Which is a key limitation of the payback period method of investment appraisal?

• It is difficult and time-consuming to calculate
• It ignores cash flows received after the payback point
• It requires a discount rate to be estimated
• It cannot be used for machinery purchases

Answer: It ignores cash flows received after the payback point

Payback focuses only on how quickly the initial cost is recovered and ignores the size and timing of cash flows beyond that point, so a project could pay back quickly yet be less profitable overall.

A project has a net present value (NPV) of −8000. According to the NPV decision rule, the business should:

• Accept the project because NPV is a large number
• Reject the project because NPV is negative
• Accept only if payback is under two years
• Be indifferent because NPV does not affect decisions

Answer: Reject the project because NPV is negative

A negative NPV means the discounted returns are worth less than the initial investment, so the project destroys value and should be rejected.

Project A has a payback period of 2 years and an average rate of return of 12 %. Project B pays back in 3 years and has an average rate of return of 20 %. Which statement about the two projects is correct?

• A returns the outlay sooner; B earns more overall
• A earns a higher return over the project's life
• B recovers the initial outlay more quickly
• B is the safer choice for a firm short of cash

Answer: A returns the outlay sooner; B earns more overall

The two methods answer different questions — how fast the money comes back, and how much the project earns — and here they point to different projects. That conflict is the reason a business applies both rather than one.

A project has an average rate of return of 15 %. This means that in an average year the project is expected to:

• earn a profit equal to 15 % of the sum invested
• return 15 % of the outlay as cash inflow
• raise the firm's total revenue by 15 %
• recover 15 % of its cost before interest is charged

Answer: earn a profit equal to 15 % of the sum invested

The numerator of ARR is average annual profit — total inflows less the initial cost, spread over the project's life — and the denominator is the amount invested. Reading the percentage as a share of cash received, or of revenue, is the standard error.