What are the advantages and disadvantages of payback period?
Payback period advantages include the fact that it is very simple method to calculate the period required and because of its simplicity it does not involve much complexity and helps to analyze the reliability of project and disadvantages of payback period includes the fact that it completely ignores the time value of ...
The payback period is especially useful for a business that tends to make relatively small investments, and so does not need to engage in more complex calculations that take other factors into account, such as discount rates and the impact on throughput.
Ignores the time value of money: The most serious disadvantage of the payback method is that it does not consider the time value of money. Cash flows received during the early years of a project get a higher weight than cash flows received in later years.
It helps a company to determine whether to invest in a project or not. If the discounted payback period of a project is longer than its useful life, the company should reject the project. One of the disadvantages of discounted payback period analysis is that it ignores the cash flows after the payback period.
Advantages of the payback period include that it is easy to calculate, easy to understand, and that it is based on cash flows rather than on accounting profits.
It helps a company in a competitive market to choose its investments wisely. Capital budgeting presents whether an investment would increase the company's value or not. It offers adequate control over expenditure for projects. Also, it allows management to abstain from over-investing and under-investing.
Ignores Time Value of Money
This is among the major disadvantages of the payback period that it ignores the time value of money, which is a very important business concept.
Answer: (A) The time value of money is ignored. It ignores cash flows beyond the payback period.
Answer: D. It ignores the expected profitability of a project. A disadvantage of the cash payback technique is that it ignores the expected... See full answer below.
NPV Advantages | NPV Disadvantages |
---|---|
Incorporates time value of money. | Accuracy depends on quality of inputs. |
Simple way to determine if a project delivers value. | Not useful for comparing projects of different sizes, as the largest projects typically generate highest returns. |
What are the advantages and disadvantages of investment appraisal?
Advantage: helps in making an investment decision based on net cash flows, their timing, and their opportunity cost. Disadvantage: clumsy to use when comparing two investments of different size or covering different time periods. The time it takes to recoup the initial outlay.