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

• A. The payback method considers all cash flows over the entire life of a project.
• B. The payback method is the most accurate method for evaluating profitability.
• C. The payback method discounts future cash flows to present value.
• D. The payback method ignores the time value of money.

Answer: (D)

Verified step by step guidance

1. Understand the payback method: The payback method is a capital budgeting technique used to determine the time it takes for an investment to recover its initial cost through cash inflows. It is a simple and quick way to assess the risk and liquidity of a project.
2. Clarify the limitations of the payback method: The payback method does not consider the time value of money, meaning it does not discount future cash flows to their present value. This is a key limitation because it ignores the fact that money received in the future is worth less than money received today.
3. Evaluate the statement about cash flows: The payback method only considers cash flows until the initial investment is recovered. It does not account for cash flows beyond the payback period, which means it does not evaluate the profitability of the entire project.
4. Assess the accuracy of the payback method: The payback method is not the most accurate method for evaluating profitability because it ignores factors like the time value of money, cash flows after the payback period, and the overall return on investment.
5. Identify the correct statement: Based on the characteristics of the payback method, the correct statement is that the payback method ignores the time value of money. This aligns with the method's limitations and its focus on recovering the initial investment without discounting future cash flows.