CPA-04836

Which of the following statements is true regarding the payback method?

a.

It is the time required to recover the investment and earn a profit.

b.

It is a measure of how profitable one investment project is compared to another.

c.

The salvage value of old equipment is ignored in the event of equipment replacement.

d.

It does not consider the time value of money.

Explanation

Choice “d” is correct. The payback method determines the number of years that it will take for a company to recoup or be paid back for its investment. The payback method does not consider the time value of money.

Choice “a” is incorrect. The payback method determines the number of years that it will take for a company to recoup or be paid back for its investment. Although the payback method focuses on liquidity, project cash flows after the initial investment are not considered; thus, profitability is ignored.

Choice “b” is incorrect. The payback method determines the number of years that it will take for a company to recoup or be paid back for its investment. Although the payback method focuses on liquidity, project cash flows after the initial investment are not considered; thus, profitability is ignored.

Choice “c” is incorrect. Salvage value is specifically considered as part of payback computations because it contributes to the incoming cash flow when the asset is sold.