ICAEW BIP · Chapter 13 · Question 6 of 9
Which of the following is a disadvantage of the payback method of investment appraisal?
Test yourself: pick an answer
Reveal answer & explanation
Correct answer: B) It ignores cash flows arising after the payback period and, in its simple form, the time value of money
Explanation
Payback measures how quickly the initial investment is recovered. It is simple to understand and favours liquidity, but it ignores all cash flows after the payback point and, unless discounted payback is used, the timing of cash flows within the period. Using accounting profit is a weakness of ARR, and needing a cost of capital applies to NPV.
More Investment appraisal MCQs
- Q8A company is appraising a new plant costing £300,000. Annual net cash inflows before environmental costs will be £120,000 for 4 years. The…
- Q9In a net present value calculation for a new production line, which of the following should be included as a relevant cash flow?
- Q1A project needs an initial investment of £180,000. Net cash inflows are expected to be: year 1 £45,000, year 2 £55,000, year 3 £70,000…
- Q2A machine costs £240,000 and will be sold for £40,000 at the end of its 5-year life. Total net cash inflows from the machine over the 5…
- Q3A project needs an investment of £150,000 now and will generate net cash inflows of £42,000 a year for 5 years, starting in one year's…