Suppose a Firm Relies Exclusively on the Payback Method When

question 59

Multiple Choice

Suppose a firm relies exclusively on the payback method when making capital budgeting decisions,and it sets a 4-year payback regardless of economic conditions.Other things held constant,which of the following statements is most likely to be true?

• A) It will accept too many short-term projects and reject too many long-term projects (as judged by the NPV).
• B) It will accept too many long-term projects and reject too many short-term projects (as judged by the NPV).
• C) The firm will accept too many projects in all economic states because a 4-year payback is too low.
• D) The firm will accept too few projects in all economic states because a 4-year payback is too high.
• E) If the 4-year payback results in accepting just the right set of projects under average economic conditions,then this payback will result in too few long-term projects when the economy is weak.

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Definitions:

Standard Scores

Scores that are derived from the process of standardization, allowing different datasets to be compared by converting variables to a common scale.

Debt-equity Ratio

An indicator of a business's debt leverage, computed by dividing the sum of its liabilities by the equity owned by its stockholders.

Financial Planning

The process of estimating the capital required and determining its competition; it is the process of framing financial policies in relation to procurement, investment and administration of funds of an enterprise.

Fixed Percentage

A predetermined, unchanging fraction or rate used in various financial contexts, such as a fixed-rate mortgage.