Question

For which capital investment evaluation technique is the following a complete list of its disadvantages when compared to NPV analysis?

(1) Ignores cash flows beyond the cutoff date;
(2) Requires an arbitrary cutoff point;
(3) Biased against long-term projects;
(4) May reject positive NPV projects,
A)NPV
B)IRR
C)Payback period
D)AAR
E)Discounted payback

Answer 1

The method with the listed disadvantages is the Payback Period, which does not consider cash flows after a cutoff date, the time value of money, and may undervalue long-term projects.

Step-by-step explanation:

The capital investment evaluation technique that lists the disadvantages as (1) ignores cash flows beyond the cutoff date; (2) requires an arbitrary cutoff point; (3) biased against long-term projects; and (4) may reject positive NPV projects is the Payback Period method. The Payback Period method simply calculates how long it will take for an investment to generate cash flows sufficient to recoup the original investment. This method does not take into account the time value of money or cash flows that occur after the cutoff point, which can be particularly problematic when comparing long-term projects that may generate significant cash flows well into the future.