Question

Please Answer Both! Thank you

23. A significant flaw in the payback method of capital budgeting is that____________

Question 23 options:

it is calculated using arithmetic average instead of weighted moving average.

it assumes future cash flows are reinvested at the IRR.

it ignores cash flows following the payback period.

it only calculates present values prior to comparing them to investment amount.

24. A project will cost $20,000 in total investment. The cash flows are as follows: Year 1: $5,000? Year 2: $3,000? Year 3: $6,000? Year 4: $8,000? Year 5: $7,000. Assume the cash flows are distributed evenly throughout the year. Calculate the exact payback period.

Question 24 options:

	3 years
	3.40 years
	4 years
	3.75 years

Answer 1

Question 23;

Answer is option (it ignores cash flows following the payback period.)

Explanation;

As we know that under payback method of capital budgeting we calculate time period in which initial investment is returned with the help of initial investment and annual cash inflows.

So Payback period method does not recognize cash inflows after calculated payback period of a project. Thus correct answer is option (it ignores cash flows following the payback period.)

Question 24;

Answer is option 3.75 years

Explanation;

Year	Cash flows	Cummulative cash flows
0	($20000)	($20000)
1	$5000	($15000)
2	$3000	($12000)
3	$6000	($6000)
4	$8000	$2000
5	$7000	$9000

Payback period = 3 + $6000 / $8000

Payback period = 3 + 0.75

Payback period = 3.75 years