Payback is considered an unsophisticated capital budgeting technique because it a) gives explicit consideration to the timing of cash flows and therefore the time value of money b) gives explicit consideration to risk exposure due to the use of the cost of capital as a discount rate c) does not give explicit consideration on the recovery of initial investment and possibility of a calamity d) it ignores the time value of money (no compounding)
Payback is considered an unsophisticated capital budgeting technique because it a) gives explicit consideration to the timing of cash flows and therefore the time value of money b) gives explicit consideration to risk exposure due to the use of the cost of capital as a discount rate c) does not give explicit consideration on the recovery of initial investment and possibility of a calamity d) it ignores the time value of money (no compounding)
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
Problem 1PS
Related questions
Question
Payback is considered an unsophisticated capital budgeting technique because it _______.
Transcribed Image Text:### Understanding the Payback Period in Capital Budgeting
**Question:**
Payback is considered an unsophisticated capital budgeting technique because it _______.
**Options:**
- **a) gives explicit consideration to the timing of cash flows and therefore the time value of money**
- **b) gives explicit consideration to risk exposure due to the use of the cost of capital as a discount rate**
- **c) does not give explicit consideration on the recovery of initial investment and possibility of a calamity**
- **d) it ignores the time value of money (no compounding)**
**Explanation:**
**Option a:** This option suggests that the payback method does give consideration to the timing of cash flows and the time value of money. However, this is incorrect as the payback method does not account for the time value of money.
**Option b:** This implies that the payback method would consider risk exposure and the use of cost of capital, which is also not true for the payback period calculation.
**Option c:** Indicates the method does not consider the recovery of initial investment and the possibility of a calamity. This is also incorrect as the main purpose of the payback method is to determine how long it takes to recover the initial investment, even though it overlooks other risks and aspects.
**Option d:** This is the correct answer. The payback period calculation ignores the time value of money because it does not discount future cash flows, making it an unsophisticated method for capital budgeting compared to other methods like Net Present Value (NPV) or Internal Rate of Return (IRR) which do account for the time value of money through compounding.
By understanding these points, it becomes clear why the payback period is considered a basic and less sophisticated method in capital budgeting techniques. It provides a quick estimate of investment recovery time but lacks a comprehensive analysis of financial viability.
Expert Solution
This question has been solved!
Explore an expertly crafted, step-by-step solution for a thorough understanding of key concepts.
This is a popular solution!
Trending now
This is a popular solution!
Step by step
Solved in 2 steps
Knowledge Booster
Learn more about
Need a deep-dive on the concept behind this application? Look no further. Learn more about this topic, finance and related others by exploring similar questions and additional content below.Recommended textbooks for you
Essentials Of Investments
Finance
ISBN:
9781260013924
Author:
Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:
Mcgraw-hill Education,
Essentials Of Investments
Finance
ISBN:
9781260013924
Author:
Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:
Mcgraw-hill Education,
Foundations Of Finance
Finance
ISBN:
9780134897264
Author:
KEOWN, Arthur J., Martin, John D., PETTY, J. William
Publisher:
Pearson,
Fundamentals of Financial Management (MindTap Cou…
Finance
ISBN:
9781337395250
Author:
Eugene F. Brigham, Joel F. Houston
Publisher:
Cengage Learning
Corporate Finance (The Mcgraw-hill/Irwin Series i…
Finance
ISBN:
9780077861759
Author:
Stephen A. Ross Franco Modigliani Professor of Financial Economics Professor, Randolph W Westerfield Robert R. Dockson Deans Chair in Bus. Admin., Jeffrey Jaffe, Bradford D Jordan Professor
Publisher:
McGraw-Hill Education