Question

which of the following capital budgeting rules does not use the time value of money concept?

a) NPV

b) IRR

c) the discounted payback period

d) the profitability index

E) the payback period

Please explain why

Thank you

Answer 1

The Answer is “E. The Payback Period”

- In Capital Budgeting, The Payback Period method does not use the concept of Time Value of money

- The Payback Period Method refers to the period in which the proposed project will generate the cash inflows to recover the Initial Investment costs.

- It considers only three components such as Initial Investment costs, Economic life of the project and the annual cash inflows

- It does not consider the concept of time value of money

- Payback period computes the number of years taken to recover the total amount of money invested in the project

- Payback period = Initial Investment / Annual cash inflows

- If the payback period is less than the enterprises required number of years, then the project should be accepted, Else it is rejected