The payback period has the following weaknesses as decision criterion for capital projects: Uses accounting income instead of cash flows Ignores cash flows beyond the payback period Does not take into account the time value of money yes yes yes no yes yes yes yes no yes no no

The payback period has the following weaknesses as decision criterion for capital projects: Uses accounting income instead of cash flows Ignores cash flows beyond the payback period Does not take into account the time value of money yes yes yes no yes yes yes yes no yes no no

Cornerstones of Cost Management (Cornerstones Series)

4th Edition

ISBN:9781305970663

Author:Don R. Hansen, Maryanne M. Mowen

Publisher:Don R. Hansen, Maryanne M. Mowen

Chapter19: Capital Investment

Section: Chapter Questions

Problem 20E

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Concept explainers

Production Budget

A budget can be defined as a financial plan designed by an undertaking for a definite period in the future that can contribute towards enhancing the financial success of the business undertaking. It is used to estimate the revenue and expenses. The budget generally takes into account both current and future income and expenses.

Question

The payback period has the following weaknesses as decision criterion for capital projects:

Uses accounting income instead of cash flows	Ignores cash flows beyond the payback period	Does not take into account the time value of money
yes	yes	yes
no	yes	yes
yes	yes	no
yes	no	no

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Discuss the principal limitations of the cash payback method for evaluating capital investment proposals.
Which of the following is a problem with using payback period for capital budgeting decisions bias against long term projects in favor of short term projects bias against short term projects in favor of long term projects time value of money conceptual violation
Why the payback method is often considered inferior to discounted cash flow in capital investment appraisal? Select one: a. It is more difficult to calculate b. It does not calculate how long it will take to recoup the money invested c. It only takes into account the future income of a project d. None of the option e. It does not take account of the time value of money
Which of the following statements indicate a disadvantage of using the discounted payback period for capital budgeting decisions? Check all that apply. The discounted payback period does not take the project’s entire life into account. The discounted payback period does not take the time value of money into account. The discounted payback period is calculated using net income instead of cash flows.
Which of the following statement about the payback period method for capital budgeting decisions is not correct? The paybackperiod method ignores the time valueof money. A shorter payback period does not always mean that one investment is more desirable than another. When the annual net cash inflow isthe same each year, the payback period = Investment required/Annual netcash inflow. When the net cash flows change from year to year, the payback period = Investment required/Average netcash inflow per year.
Which of the following statements concerning the payback period, is not true? a. The payback period measures the time that a project will take to generate enough cash flows to cover the initial investment.incorrect b. the payback period involves a simple method c. the payback period takes into account the time value of money d. the payback period ignores cash flows
Which of the following statements is true with regard to cash flows resulting from financing costs? a. They should be included in the cash flow calculations. b. Financing cash flows cannot include dividend payments to stockholders and interest payments to bondholders. c. Financing costs are captured in the original investment of a project’s cash flows. d. If cash outflows associated with financing costs were deducted from the cash flows for a project, it would be double-counting the financing costs of the investment.
Which of the following statements is false? A. Net incomes are not cash flows. Financial Managers should focus on the cash flows when making capital budgeting decisions. B. Incremental earnings are the amount by which the firm's earnings are expected to change as a result of the investment decision. C. To the extend that overhead costs are fixed and will be incurred in any case, they are not incremental to the project and should be excluded in the capital budgeting analysis. D. Depreciation is not a cash expense paid by the firm. E. None of the above.
Companies often use several methods to evaluate the project’s cash flows and each of them has its benefits and disadvantages. Based on your understanding of the capital budgeting evaluation methods, which of the following conclusions about capital budgeting are valid? Check all that apply. The discounted payback period improves on the regular payback period by accounting for the time value of money. For most firms, the reinvestment rate assumption in the NPV is more realistic than the assumption in the IRR. Because the MIRR and NPV use the same reinvestment rate assumption, they always lead to the same accept/reject decision for mutually exclusive projects. True or False: Sophisticated firms use only the NPV method in capital budgeting decisions.
Discuss the notions of conventional and nonconventional cash flows in capital budgeting. Which investment evaluation criteria would you use for unconventional cash flows and why? Provide a fictitious unconventional cash flow example and apply the payback period, NPV, IRR, MIRR, and PI methods to your example. Interpret the results.
In capital budgeting, a project is accepted only if the internal rate of return equals or: a. exceeds the net present value b. is less than the required rate of return c. exceeds the required rate of return d. exceeds the accrual accounting rate of return
Assume a project has normal cash flows. All else equal, which of the following statements is CORRECT? a. A project's NPV increases as the cost of capital declines. b. A project's MIRR is unaffected by changes in the cost of capital. c. A project's regular payback increases as the cost of capital declines. d. A project's discounted payback increases as the cost of capital declines. e. A project's IRR increases as the cost of capital declines.