True or False, Why? 1) The payback period rule, unlike the net present value rul

Question

True or False, Why?

1) The payback period rule, unlike the net present value rule, adjusts for the riskiness of an investment

2) Information signaling can occur in a variety of ways including through earnings releases, changes in dividend policy, inside stock trades, or other SEC filings.

3)  In addition to determining what investments create the most value, a finance manager will also need to determine which mix of capital is optimal for financing the investment alternatives

4) When it comes to insuring your home you want the insurance company to provide you with appraised value

Explanation / Answer

Solution 1

False

The payback period is the period to recover the initial investment. Under this criterion, the focus is on liquidity rather than risk. Payback period method does not use cost of capital or required return, this is why it does not incorporate riskiness of the project.

Payback period = Initial Investment/ Annual Cash flow

From the above given formula, it can be inferred that Payback period method does not use any discount rate to calculate the PV or Future value of cash flow. Also, it does not use any other tool to incorporate project risk.   

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