Question

The payback method

Multiple Choice

A. requires each firm to set a firmwide cash flow cutoff period.

B. superior to the net present value method.

C. ignores the time value of money.

D. discounts all cash flows properly.

Answer 1

THE PAYBACK PERIOD

CORRECT ANSWER : C : IGNORES TIME VALUE OF MONEY

PAYBACK PERIOD IS DEFINED AS TIME PERIOD REQUIRED TO RECOVER THE INVESTMENT

SO IF INVESTMENT = 100000 AND CFAT PER YEAR = 25000, THEN WE CAN SAY PAYBACK PERIOD = 100000/25000 = 4 YEARS.

IT DOES NOT TAKE INTO THE CASHFLOWS THAT ARE RECEIVED AFTER PAYBACK PERIOD. IT IGNORES THE VALUE OF MONEY.

SO ALL CFATS ARE TREATED EQUALLY WHETHER RECEIVED TODAY OR TOMORROW

NPV (NET PRESENT VALUE) TAKES INTO ACCOUNT TIME VALUE OF MONEY & DISCOUNTS ALL CFAT PROPERLY, SO NPV IS SUPERIOR THAN PAYBACK PERIOD

FIRST OPTION IS IRRELEVANT AS NOTHING IS SPECIED RELATED TO CUTOFF PERIOF IN PAYBACK PERIOD DEFINITION