payback period

Business & Finance
Tutor: None Selected Time limit: 1 Day

Why is the payback period not a preferred method in the capital budgeting decision-making process? Which capital budgeting valuation method is most preferred and why?

Apr 11th, 2015

1. The payback period method is antiquated and falling into disuse, because it has some significant drawbacks. It doesn't take into account the time value of money, and it tends to favor very cyclical products that make the bulk of their money up front, rather than those that build momentum and can produce cash inflows over a long period. The cash inflows from a project may be irregular, with most of the return not occurring until well into the future. A project could have an acceptable rate of return but still not meet the company's required minimum payback period. The payback model does not consider cash inflows from a project that may occur after the initial investment has been recovered. 

2.NPV method is considered the favorable one among analysts, the IRR and PB are often used as well under certain circumstances. Managers can have the most confidence in their analysis when all three approaches indicate the same course of action.


Apr 11th, 2015

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