Assuming that the project under consideration has normal cas

Assuming that the project under consideration has normal cash flows, with one initial cash outlay followed by various cash inflows. Which of the following statements is accurate?

a. If a company uses the same payback requirement to evaluate all projects, say it requires a payback of 4 years or less, then the company will tend to reject projects with relatively short lives and accept long-lived projects, and this will cause its risk to increase over time.

b. One drawback of the payback criterion for evaluating projects is that this method does not properly account for the time value of money.

c. The regular payback ignores cash flows beyond the payback period, but the discounted payback method overcomes this problem.

d. The longer a project\'s payback period, the more desirable the project is normally considered to be by this criterion.

Solution

Only statement (b) is correct

Payback period method is a non-discounting method. It does not take into account time value of money. It considers cash flows from a project without considering time value of money.

Statement (a) is incorrect since while evaluating projects on the basis of payback period method, lives of the projects are not considered. It is only the payback period of projects which is considered.

Statement (c) is incorrect since both regular payback period method and discounted payback period method ignore the cash flows beyond the payback period.

Statement (d) is incorrect since according to payback method, lower the payback period, better it is. A project with shorter payback period is preferred over the project having longer payback period.