Question

Rank the following decision rules from worst to best in terms of their overall usefulness in capital budgeting analysis.

I. NPV
II. Payback
III. IRR
A) II, III, I
B) II, I, III
C) III, I, II
D) I, III, II
E) III, II, I

Answer 1

In capital budgeting analysis, the Payback Period is the least useful, followed by the Internal Rate of Return, with the Net Present Value being the most useful. Therefore, the correct ranking from worst to best is option A) II, III, I.

Step-by-step explanation:

The question focuses on the ranking of decision rules used in capital budgeting analysis. The decision rules in question are Net Present Value (NPV), Payback Period, and Internal Rate of Return (IRR). In terms of overall usefulness, NPV is often considered the most informative because it accounts for the time value of money and provides the net value of future cash flows in today's dollars.

IRR is also useful as it determines the rate of return at which the net present value is zero, but it can be problematic when comparing projects with different cash flow patterns. The Payback Period is the least useful because it ignores the time value of money and cash flows that occur after the payback period.

Ranking of Decision Rules from Worst to Best:

1. Payback Period (Worst)
2. Internal Rate of Return
3. Net Present Value (Best)

Thus, the correct ranking from worst to best is Payback, IRR, NPV, which corresponds to option A) II, III, I.