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Greetings Tutor. I hope you are doing well.
Can you please help me with the following question.Q- Indicate, by clicking in the relevant boxes, whether the following statements on the payback period are true or false
a) It is a risk-focussed approach in decision-making
As per Kaplan Exam kit the statement is true. But no explanation has been provided.
Considering the fact that Risk and Uncertainty are actually different, with risk increasing as the variability of return increases, whereas Uncertainty increases when the length of the project’s life increases.
So Payback period is a more Uncertainty focused approach as keeping a shorter payback period would pressurize the project to pay sooner and with more certainty we could forecast cash flows.
And also we don’t use probabilities anywhere in Payback periods.
So shouldn’t the statement be False instead of True.So I would say this is an ambiguous question because on one hand the statement that the payback period is a risk-focused approach in decision-making is considered true because it emphasises minimising the risk associated with investment decisions.
The payback period method prioritises the time it takes to recover the initial investment, which inherently addresses the uncertainty of future cash flows. By focusing on how quickly an investment can be recouped, it helps decision-makers assess the risk of potential losses.But you could argue that it does not explicitly account for the uncertainties of future cash flows, making it less comprehensive in risk assessment compared to other methods like NPV or IRR. It primarily measures the time required to recover the initial investment, without considering the risk associated with future cash flows or the time value of money.
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