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Chapter 26: Q10RQ (page 1463)

What is the decision rule for payback?

Short Answer

Expert verified

Answer

The general rule is that investments with shorter payback periods are observed as more appropriate and preferable.

Step by step solution

01

Meaning of Payback

The payback period is used to compare projects in capital arrangements and evaluate the time it takes for the initial venture to recover in years. The payback period is the time it takes to recover the initial expense.

02

Decision rule for payback

The greater the risk, the longer the project's payback period. If two ventures with equal returns are commonly contradictory, the choice ought to be made to contribute to the project with the most limited payback period.

The payback period refers to the amount of time it takes for the initial investment in a project to be returned by future cash flows. The best project is the one that helps the company return its investment the quickest, and it is the one to which the company should devote its resources.

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Most popular questions from this chapter

Using the time value of money Helen wants to take the next four years off work to travel around the world. She estimates her annual cash needs at $31,000 (if she needs more, she will work odd jobs). Helen believes she can invest her savings at 10% until she depletes her funds. Requirements

  1. How much money does Helen need now to fund her travels?
  2. After speaking with a number of banks, Helen learns she will only be able to invest her funds at 6%. How much does she need now to fund her travels?

Match the following business activities to the steps in capital budgeting process.

Steps in the capital budgeting process:

a. Develop strategies

b. Plan

c. Direct

d. Control

Business activities:

1. A manager evaluates progress one year into the project.

2. Employees submit suggestions for new investments.

3. The company builds a new factory.

4. Top management attends a retreat to set long-term goals.

5. Proposed investments are analyzed.

6. Proposed investments are ranked.

7. New equipment is purchased.

What are post-audits? When are they conducted?

Using accounting rate of return to make capital investment decisions

Carter Company is considering three investment opportunities with the following accounting rates of return:

Project X

Project Y

Project Z

ARR

13.25%

6.58%

10.47%

Use the decision rule for ARR to rank the projects from most desirable to least desirable. Carter Company鈥檚 required rate of return is 8%.

Question: Defining capital investment terms

Fill in each statement with the appropriate capital investment analysis method:

Payback, ARR, NPV, or IRR. Some statements may have more than one answer.

  1. _____ is (are) more appropriate for long-term investments.
  2. _____ highlights risky investments.
  3. _____ shows the effect of the investment on the company鈥檚 accrual-based income.
  4. _____ is the interest rate that makes the NPV of an investment equal to zero.
  5. _____ requires management to identify the discount rate when used.
  6. _____ provides management with information on how fast the cash invested will be recouped.
  7. _____ is the rate of return, using discounted cash flows, a company can expect to earn by investing in the asset.
  8. _____ does not consider the asset鈥檚 profitability.
  9. _____ uses accrual accounting rather than net cash inflows in its computation.
See all solutions

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