Suppose a Firm Relies Exclusively on the Payback Method When

question 31

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 long-term projects and reject too many short-term projects (as judged by the NPV).
• B) The firm will accept too many projects in all economic states because a 4-year payback is too low.
• C) The firm will accept too few projects in all economic states because a 4-year payback is too high.
• D) 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.
• E) It will accept too many short-term projects and reject too many long-term projects (as judged by the NPV).

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Definitions:

Door-In-The-Face

A persuasion technique involving making a large, unreasonable request that is likely to be refused in order to increase the likelihood of agreement to a smaller request later.

Lowballing

A persuasive technique often used in sales where an initially lower price is offered to get agreement from the buyer, only for it to be raised before the sale is concluded, often for reasons made to seem unavoidable.

Informational Influence

A form of social influence that occurs when an individual turns to the members of a group to obtain and accept information about reality.

Foot-In-The-Door

A psychological technique where getting a person to agree to a small request increases the likelihood they will agree to a larger request later.