An auditor's report quotes only payback periods. The limitation to point out is that it
Answer: A
A board choosing between a lighting change and an insulation scheme needs to know that one runs for five years and the other for twenty-five, which payback conceals. Adding a present value column costs little and changes the ranking.
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A measure with a three-year payback is rejected although the hurdle is four years. The likely reason is
Answer: B
Correct answer: the capital was rationed and better measures competed for it
A measure inside the hurdle is worth doing in isolation, and it can still be refused if there is not enough capital for everything that qualifies. Under rationing the projects are ranked and the budget is spent from the top, so a perfectly acceptable measure may fall below the line.
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Assertion: simple payback is an inadequate criterion on its own. Reason: it ignores both the project's life and the time value of money.
Answer: C
Correct answer: both the assertion and the reason are true and the reason explains the assertion
Both are true and the reason gives the mechanism. Payback counts only until the capital is recovered, so it is blind to the project’s remaining life, and it treats a rupee in year three as equal to one today. Those two omissions are exactly why it is used as a screen and backed by a discounted measure before a decision is taken.
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Assertion: a project with a negative net present value loses money. Reason: its benefits are worth less than its costs in present terms.
Answer: D
In present terms the benefits are indeed the smaller, which is what the negative value states, but the project may still return more than it cost in absolute money. What it fails to do is beat the return the capital could earn elsewhere, which is a different and weaker charge.
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Comparing an appraisal in real terms with one in nominal terms, the two agree provided
Answer: A
Cash flows in today's money must meet a real rate and inflated cash flows a nominal one, and consistently applied either gives the same answer. Mixing them, by discounting today's-money savings at a nominal rate, understates every project.
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None of the following belongs in a life cycle cost comparison except
Answer: B
Maintenance persists for the whole life and may differ between the options, so it belongs alongside capital and energy. The audit fee is a sunk cost, and the other two have nothing to do with the choice between the alternatives.
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