Question

Which of the following statement is correct? Select one:

a. Since the payback period method fails to look at the cash flows beyond the payback period, it can lead to poor business decisions.

b. A firm should never accept the independent projects having NPVs greater than zero.

c. The capital budgeting projects may be about the purchase of financial asset such as investing in stocks and bonds, futures, or buying and selling T-bills.

d. The number of time periods it takes to cover the initial investment is called the net present value.

e. All the answers are incorrect.

Answer 1

From the given statements, payback period is calculated by how quickly the initial cashflows are recovered. Once the initial cashflows are recovered, the next cashflows are not taken into consideration which is a huge disadvantage from using the payback period method. So, this statement is CORRECT.

Option b is wrong as all projects with NPV>0 are deemed acceptable
Option c is incorrect since capital budgeting projects are about huge investment decisions like purchasing a machinery, investing in land/building etc and not in stock/bonds/futures etc
Option d is incorrect since the number of time periods taken to cover initial investment is the PAYBACK PERIOD and not the net present value