A significant advantage of the payback period is that it:
A. places emphasis on time value of money.
B. allows for the proper ranking of projects.
C. tends to reduce firm risk because it favors projects that generate early, less uncertain returns.
D. gives proper weighting to all cash flows.
E. None of the above
The payback period is one of the simple processes to confirm whether a project should be executed according to its length of time to recover the initial investment completely.
Answer and Explanation:
A. Incorrect. The payback period ignores the time value of money in its calculation.
B. Incorrect. We can rank the project's payback in order, but it does not provide a proper comparison due to the lack of consideration of the time value of money and cash flows after the cut-off point.
C. Incorrect. The payback period method will increase the firm risk due to missing huge cash flows after the cut-off point.
D. Incorrect. The payback method does not include the weight of cash flows in its calculation.
E. Correct. All of the above answers are eliminated.
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from Introduction to Management: Help and ReviewChapter 16 / Lesson 12