Questions: Which of the following capital budgeting methods might not consider the salvage value of a machine being considered for purchase? payback net present value internal rate of return profitability index

Which of the following capital budgeting methods might not consider the salvage value of a machine being considered for purchase? payback net present value internal rate of return profitability index
Transcript text: Which of the following capital budgeting methods might not consider the salvage value of a machine being considered for purchase? payback net present value internal rate of return profitability index
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Solution

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The answer is the first one: payback.

Explanation for each option:

  1. Payback: The payback method calculates the time required to recover the initial investment from the cash inflows generated by the project. It does not consider the time value of money, and typically, it does not take into account the salvage value of the machine. The focus is solely on how quickly the initial investment can be recouped.

  2. Net Present Value (NPV): NPV considers all cash flows associated with the project, including the salvage value. It discounts these cash flows to their present value, ensuring that the salvage value is included in the overall calculation.

  3. Internal Rate of Return (IRR): IRR also considers all cash flows, including the salvage value. It calculates the discount rate that makes the net present value of the cash flows equal to zero, thus incorporating the salvage value in the process.

  4. Profitability Index (PI): PI is the ratio of the present value of future cash flows to the initial investment. It includes all cash flows, including the salvage value, in its calculation.

Summary: The payback method might not consider the salvage value of a machine being considered for purchase, as it focuses only on the time required to recover the initial investment.

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