The length of time required for an investment's net revenues to cover its cost is known as ________.
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A. B. C. D. E.D
Payback Period is defined as the length of time required for an investment's net revenues to cover its cost.
The correct answer is D. Payback Period.
The payback period is a financial metric used in capital budgeting to assess the length of time required for an investment's net revenues (or cash flows) to recover the initial cost of the investment. In other words, it measures the time it takes for an investment to "pay back" its original investment.
The payback period is calculated by dividing the initial investment by the average annual net cash flows generated by the investment. The formula is as follows:
Payback Period = Initial Investment / Average Annual Net Cash Flows
To illustrate with an example, let's say you invest $10,000 in a project that generates net cash flows of $2,000 per year. In this case, the payback period would be:
Payback Period = $10,000 / $2,000 = 5 years
This means that it would take approximately 5 years for the investment to generate enough net cash flows to recover the initial investment of $10,000.
The payback period is often used as a simple and quick evaluation tool for investment projects. It provides a measure of liquidity and risk by indicating how long it will take to recoup the initial investment. Shorter payback periods are generally preferred, as they indicate a faster return of investment.
However, it's important to note that the payback period has limitations. It does not consider the time value of money (i.e., the fact that a dollar received in the future is worth less than a dollar received today), and it does not provide information about the profitability of the investment beyond the payback period. Therefore, it should be used in conjunction with other capital budgeting techniques, such as net present value (NPV) or internal rate of return (IRR), to make more informed investment decisions.
To summarize, the length of time required for an investment's net revenues to cover its cost is known as the payback period. It is calculated by dividing the initial investment by the average annual net cash flows and is used as a basic measure of liquidity and risk in capital budgeting.