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ACCA Strategic Professional · Strategic Business Leader · Financial analysis and decision-making techniques

Brightwell Retail is a mid-sized chain whose directors favour projects with the fastest payback because the business has limited access to new borrowing. A proposed store refurbishment pays back in 2 years but has a negative NPV at the company's cost of capital, as its cash flows are small after year 2. What does this imply?

The project should be rejected. A negative NPV means it is expected to reduce shareholder wealth, and a quick payback only shows speed of cash recovery while ignoring later cash flows and the time value of money. Liquidity matters, but it does not justify accepting a value-destroying project.

  1. AThe project should be accepted because liquidity concerns override value creation
  2. BThe project should be accepted because a short payback proves a positive IRR
  3. CThe project should be rejected because a negative NPV means it is expected to reduce shareholder wealth, even though payback is quickCorrect
  4. DThe project should be rejected because payback periods under 3 years are always unreliable

Explanation

A negative NPV indicates the project's discounted returns fall short of the required return, so it destroys value. Quick payback only shows liquidity speed and ignores cash flows beyond the cut-off and discounting. Liquidity is a legitimate secondary consideration but does not turn a value-destroying project into a sound one, and a short payback does not imply a positive IRR.

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