CAPITAL BUDGETING DECISION | BUSINESS FINANCE | NTA UGC NET COMMERCE | 2020 OCT

1. In which of the following situation, the Payback period method is advised for evaluation of investment opportunities

• Overleveraged business
• Cash-rich business
• Uncertain market conditions
• Stable market condition

Choose the correct answer from the options given below:

1. A&B b) A&C    c) B&C  d) C&D

Ans: (b)

The payback period represents the time period required for the complete recovery of the initial investment in the project. The project or investment with the shortest duration is opted for. It is the most commonly used & simple technique.

An overleveraged company has difficulty in paying its interest & principal payments and is often unable to pay its operating expense because of excessive costs due to its debt burden. Projects with long payback periods should be avoided during uncertain market conditions.

PAYBACK PERIOD = TOTAL INVESTMENT ÷ ANNUAL CASH INFLOW (BEFORE DEPRECIATION AFTER TAX)