Could you please explain why the payback period is decreasing and Internal Rate of Return increasing in the following question?
A project consists of a series of cash outflows in the first few years followed by a series of positive cash inflows. The total cash inflows exceed the total cash outflows. The project was originally evaluated assuming zero rate of inflation.
If the project were re-evaluated on the assumption that the cash flows were subject to a positive rate of inflation, what would be the effect on the payback period and the internal rate of return? Indicate, by clicking in the relevant boxes, whether payback period and internal rate of return would increase or decrease.
Method Increase Decrease
Internal Rate of Return
Answer: Payback period : Decrease , Internal Rate of Return: Increase
Incase someone is trying to understand this, following is the explanation to this:
First considering payback - if the initial outflow doesn't change but the inflows all increase as a result of inflation, then the payback period will decrease - the value of inflows increases shortening the payback period.
Just considering the effect of inflation on the internal rate of return - if inflation is now included in the cashflows, it will also be included in the rate of return (and the IRR) so the IRR becomes (1+non inflation IRR)x(1+inflation). This increases the IRR of the project.
Hey haven't started payback as yet but u have a f9 kit pdf?
Positive inflation occurs when there is a boost in consumer demand and consumption indirectly there will be an increase in cash inflow causing decrease in payback period ( period in which investment is recovered) and increasing IRR.