What is the primary concern of the payback period rule when evaluating investments in securities?

• A. It considers all future cash flows equally.
• B. It ignores the time value of money.
• C. It requires complex calculations involving discount rates.
• D. It always leads to the highest net present value.

Answer: (B)

Verified step by step guidance

1. Understand the concept of the payback period rule: The payback period is the time it takes for an investment to recover its initial cost through cash inflows. It is a simple method used to evaluate investments, but it has limitations.
2. Identify the primary concern of the payback period rule: The rule does not account for the time value of money, which is a fundamental principle in financial accounting. The time value of money states that a dollar received today is worth more than a dollar received in the future due to its earning potential.
3. Analyze why the payback period ignores the time value of money: The payback period focuses solely on the amount of time required to recover the initial investment, without discounting future cash flows to reflect their present value.
4. Compare the payback period rule to other methods: Unlike methods such as Net Present Value (NPV) or Internal Rate of Return (IRR), the payback period does not involve discount rates or complex calculations, which makes it simpler but less precise.
5. Conclude the limitations of the payback period rule: While it is useful for quick assessments, the payback period may lead to suboptimal investment decisions because it ignores the profitability of cash flows beyond the payback period and the time value of money.