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Questions:
a.According to the payback method, which project should be selected?
b. What is the chief disadvantage of this method?
c. Why would anyone want to use this method?
Solution
Answer:a
I will explain this by a example given below:
Two projects are viewed as equally attractive if they have the same payback regardless of when
the payback occurs. If both project require an initial investment of $300,000, but Project 1 has a
payback of one year and Project two of three years, the projects are viewed equally, although
Project 1 is more valuable because additional interest could be earned on the funds in year two
and three.
Answer:b
The payback period is considered a method of analysis with serious limitations and qualifications
for its use, because it does not account for the time value of money, risk, financing, or other
important considerations, such as the opportunity cost. While the time value of money can be
rectified by applying a weighted average cost of capital discount, it is generally agreed that this
tool for investment decisions should not be used in isolation.
Payback also ignores the cash flows beyond the payback period, thereby ignoring the
profitability of the project. Thus, one project may be more valuable than another based on future
cash flows, but the payback method does not capture this.
Answer:c
Anyone would use this method because of its advantages described below:

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Questions  a.According to the payback method, which project shoul.pdf

  • 1. Questions: a.According to the payback method, which project should be selected? b. What is the chief disadvantage of this method? c. Why would anyone want to use this method? Solution Answer:a I will explain this by a example given below: Two projects are viewed as equally attractive if they have the same payback regardless of when the payback occurs. If both project require an initial investment of $300,000, but Project 1 has a payback of one year and Project two of three years, the projects are viewed equally, although Project 1 is more valuable because additional interest could be earned on the funds in year two and three. Answer:b The payback period is considered a method of analysis with serious limitations and qualifications for its use, because it does not account for the time value of money, risk, financing, or other important considerations, such as the opportunity cost. While the time value of money can be rectified by applying a weighted average cost of capital discount, it is generally agreed that this tool for investment decisions should not be used in isolation. Payback also ignores the cash flows beyond the payback period, thereby ignoring the profitability of the project. Thus, one project may be more valuable than another based on future cash flows, but the payback method does not capture this. Answer:c Anyone would use this method because of its advantages described below: