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    Disadvantages of Cash Payback Method

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    Discuss the principal objections to the use of the cash payback method for evaluating capital investment proposals.

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    Discuss the principal objections to the use of the cash payback method for evaluating capital investment proposals

    A project (capital investment) involves cash investment (cash outflow) at time zero in the project and cash inflows from operations in subsequent years.

    The cash payback period is the time (generally in years) that it will take to recover, in the form of cash inflows from the project, the initial amount that has been invested in the project. The shorter the payback period, the better it is.
    In order to apply the payback period criterion, the management of a company establishes a maximum acceptable payback value (say 4 years). If the payback period of a project is less than this maximum acceptable payback value, the project is accepted, otherwise it is rejected.

    Cash payback method, while easy to understand and compute, suffers from a number of disadvantages:
    1) Cash payback method requires an arbitrary value for the cutoff payback period: The payback period in itself does not provide any guidance as to the selection or rejection of a ...

    Solution Summary

    Discusses the disadvantages of cash payback method as a capital budgeting tool.

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