Question

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).

Answer 1

Answer:

Correct option is E. The firm will accept too few projects in all economic states because a 4-year payback is too high.

Explanation:

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.