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Payback Period

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Why is the payback period not a preferred method in the capital budgeting decision-making process? Which decision-making criteria is the best to use for capital budgeting decisions? Why?

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This explains the computation of Payback Period

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Under the Payback Method, we compute the amount of time required for an investment to generate cash inflows sufficient to recover its initial cost. Based on this method, an investment is acceptable if its calculated payback period is less than some prespecified number of years. This method is perhaps the easiest to use, but it suffers some important shortcomings: (1) The payback period is calculated simply by adding up the future cash flows. There is no discounting involved, so the time value of money is completely ignored. (2) The payback rule also fails to consider risk differences. The ...

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