Project Feasibility Study: Cash Flows, NPV, and Payback Period

D

The $3 million spent on consultants represent sunk costs and must be ignored while looking toward the future. In that direction, the project has a positive NPV and should be accepted.

To determine whether the firm should accept or reject the project, let's analyze the given information.

Net Present Value (NPV) is a financial metric used to assess the profitability of an investment project. It calculates the present value of expected cash flows by discounting them using a required rate of return. A positive NPV indicates that the project's expected cash inflows exceed the initial investment, while a negative NPV suggests the opposite.

In this case, the consultants have determined that the project's cash flows have a net present value of $1.3 million. This means that the present value of the expected cash inflows from the project exceeds the initial investment of $3 million by $1.3 million. Therefore, the project has a positive NPV.

The payback period is the length of time required for an investment to recover its initial cost. In this case, the consultants have determined that the payback period for the project is 5.3 years.

Now, let's analyze the answer choices:

A. Reject the project since it has a long payback period. The given information does not indicate whether a payback period of 5.3 years is considered long or short in the context of this project. Additionally, the payback period is not the only factor to consider when evaluating a project's viability. Therefore, this answer is not necessarily correct.

B. Reject the project since it has a negative NPV. The given information states that the project has a positive NPV of $1.3 million. Therefore, this answer is incorrect.

C. None of these answers. This answer choice could be correct if the other options are not valid. However, we should continue analyzing the remaining options.

D. Accept the project since it has a positive NPV. As mentioned earlier, a positive NPV suggests that the project's expected cash inflows exceed the initial investment. Therefore, accepting the project is a reasonable decision based on the given information. This answer is consistent with the positive NPV of $1.3 million. Hence, this answer seems to be the most appropriate choice.

In conclusion, based on the information provided, the firm should accept the project since it has a positive NPV. Therefore, the correct answer is D.