Certified Management Accountant Practice Exam

In what scenario is the payback period particularly useful?

1. When considering projected cash flows.

2. When the timing of future cash inflows is uncertain.

3. When evaluating high-risk investments.

4. When liquidity is a primary concern.

The correct answer is: When liquidity is a primary concern.

The payback period is especially useful in scenarios where liquidity is a primary concern because it focuses on the time it takes for an investment to generate enough cash inflows to recover its initial cost. Investors or companies that prioritize liquidity need to know how quickly they can return their capital, as having cash available is critical for meeting operational needs, investing in further opportunities, or covering unexpected expenses. In this context, the payback period provides a straightforward metric that highlights the investment's risk related to cash flow timing by examining how soon capital is recouped, rather than relying on uncertain long-term projections or potential returns which may not materialize in the short term. This makes it an integral part of evaluating investments, particularly when there is a risk of cash scarcity or when immediate financial stability is paramount.