One advantage of the Payback Period Ratio is its simplicity of calculation and understanding. Nevertheless, it has two major defects:
It ignores any benefit that may occur after the payback period
It ignores the Time value of Money
Agree or disagree?
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The payback period ratio definitely has simplicity on its side as an advantage. The basic formula of the equation is, in fact an advantage as compared to the other methods most commonly used, which take ample amounts of time to calculate. The method to calculate the payback period ratio is:
Payback period = investment required / net annual cash flows.
This method focuses on recovering the cost of the investment. The payback period indicates the amount of time that it takes for a project financed through capital budgeting to recover the initial cost, but does not take other factors into ...
The solution provides a detailed discussion that includes the advantages, disadvantages, and possible defects of the Payback Period Ratio. References are also included.