All of the following are criticisms of the payback period criterion except:
A. time value of money is not accounted for.
B. cash flows occurring after the payback are ignored.
C. it deals with accounting profits as opposed to cash flows.
D. None of the above; they are all criticisms of the payback period criteria.
Capital budgeting refers to the process of analyzing various investment projects and choosing the project which maximizes the shareholders's wealth. In situation of capital rationing (where there are capital constraints and all investment projects can not be chosen), it is very important to choose the appropriate capital budgeting technique. Some capital budgeting techniques use time value of money (like NPV), while some do not use time value of money (like payback period).
Answer and Explanation:
Payback period refers to the time period which is required to recover the initial investment in the project.
A. time value of money is not accounted for- This is a criticism to payback period. It uses cash flows without discounting them.
B. cash flows occurring after the payback are ignored- This is a criticism to payback period. Any cash flows occurring after payback period like salvage value, cash inflows etc. are ignored
C. it deals with accounting profits as opposed to cash flows- This is not a criticism to payback period. It used cash flows and not accounting profit.
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from Financial Accounting: Help and ReviewChapter 5 / Lesson 24