Assuming other factors remain constant, what causes lower project liquidity__________?
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Answer: B. greater payback period
Explanation
A longer payback period means capital is tied up longer, resulting in lower project liquidity. Projects that take many years to recover their initial investment reduce a firm's financial flexibility. Shorter capital recovery timelines ensure that cash returns quickly to the business for new opportunities. Payback period measures the exact amount of time required for a project to recover its initial cash outlay. Liquidity describes how quickly an asset or capital investment can be converted into spendable cash. Capital budgeting decisions weigh project profitability against the inherent risks associated with reduced liquidity.
Corporate finance managers prioritize investments with faster payback periods during periods of economic uncertainty. Low liquidity exposes a company to cash flow shortages if unexpected operational expenses arise suddenly. Evaluators use payback analysis as a supplementary tool alongside net present value and internal rate of return. Shorter payback period accelerates capital recovery, thereby increasing rather than decreasing overall project liquidity. Less project return affects overall profitability rather than directly dictating the speed of capital recovery. Greater project return enhances total profitability while payback duration dictates the timing of cash inflows.
- Subject
- Accounting and Finance
- Category
- Finance
- Topic
- —
- Difficulty
- medium
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