Question

A disadvantage of using the payback period to compare investment alternatives is that:

Multiple Choice
a. It ignores cash flows beyond the payback period.
b. It includes the time value of money.
c. It cannot be used when cash flows are not uniform.
d. It cannot be used if a company records depreciation.
e. It cannot be used to compare investments with different initial investments.

Answer 1

Answer: Option a

Step-by-step explanation: Payback period in capital budgeting comes from a time needed to recover or exceed the break-even point of the funds spent on a project. Moreover, the payback period does not take into account the time value of money.

It is based on the number of years it would take for the funds spent to be recovered. Thus, payback period only evaluates a project on the basis of time period it takes to recover back the investment this results in ignorance of cash flows, which might be huge in amount, that results after the pay back period.