Question

Which of the following statements is correct for a typical investment project? (There may be multiple correct answers!)

1. “NPV > $0” means “Profitability Index > 0”
2. “NPV > $0” means “IRR > required return”
3. “Profitability Index > 1” means “IRR > required return”
4. “NPV = $1” means “Profitability Index = 1” and also “IRR = required return”
5. “Payback period = required payback” means “NPV = $0”

Answer 1

Statements a,b and c are correct

Explanation:-As we know that NPV is present value of cash inflows less Initial investment and if NPV is positive i.e,greater than zero ,it means present value of cash inflows is greater than Initial investment.

And Profitability index will also be greater than 1 in that case because PI is equal to Present value of cash inflows divided by Initial investment.

And IRR will also be greater than required return in that case because IRR is the rate at which NPV becomes zero.For calculating NPV ,we use required rate of return and here NPV is positive and to make it zero ,we need to decrease present value of cash inflows and for that, rate should be higher than required return .Therefore IRR will be greater than required return.