Practice : a: The computation of return on average investment ignores one characteristic of the earnings stream, which is considered in discounting cash flows. What is this characteristic? Why is it important?b: What are the disadvantages of evaluating an investment using payback period? Why might a company use this methodology despite these disadvantages?

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Asked Nov 3, 2019
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Practice :

a: The computation of return on average investment ignores one characteristic of the earnings stream, which is considered in discounting cash flows. What is this characteristic? Why is it important?

b: What are the disadvantages of evaluating an investment using payback period? Why might a company use this methodology despite these disadvantages?

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Expert Answer

Step 1

Capital budgeting refers to the technique of evaluating a project for investing in it. It has different methods that are used to check the profitability of project and taking decisions for investing long term funds in the project.

Step 2

(a)

The return on average investment ignores the characteristic of net present value which is present in discounted cash flows. Net present value is an important concept as it describes the value of future money at present. It depicts what amount of today’s money will be equal to future amount of money.

While investing in a project, the retu...

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