Question

Which of the following ignores late cash flows?
I. Profitability index
II. Discounted payback period
III. Net present value
IV. Payback period

I and III only

II and IV only

I, II, and III only

I, III, and IV only

Answer 1

The capital budgeting methods that ignore late cash flows are :-

Discounted payback period and payback period

So, the right answer is ----- II and IV only

Explanation :-

In payback period and discounted payback period method , cashflows upto the time of full recovery of initial cost is considered , the cash flows to be generated after the payback period are not taken into consideration and are ignored.

For Example :- Suppose a project has cash inflows for 5 years but payback period is 3 years, then the cash flows occuring in year 4 and 5 are ignored .

Discounted payback period method only discounts the cash flows to present value , otherwise it is same as payback period method and ignores the cash flows generated after the discounted payback period .

Explanation for rejection of other points :-

Net present value and profitability index method consider all the cash flows generated by a project . These method does not ignore the late cash flows .

So, the right answer is ( II and IV only )