What are the weaknesses of Payback period over NPV? [4]
Question
What are the weaknesses of Payback period over NPV? [4]
Solution
-
Ignores Time Value of Money: The most significant weakness of the Payback Period method is that it does not consider the time value of money. This means it treats all cash flows as if they occur at the same point in time, which is not realistic. On the other hand, Net Present Value (NPV) takes into account the time value of money by discounting future cash flows back to their present value.
-
Ignores Cash Flows After Payback Period: The Payback Period method only considers the cash flows until the initial investment is recovered and ignores any cash flows that occur after the payback period. This can lead to incorrect decision making as it does not consider the total profitability of a project. NPV, however, considers all cash flows throughout the project's life.
-
No Profitability Measure: Payback period does not provide a measure of profitability or the return on investment. It only tells how quickly the initial investment can be recovered. NPV, on the other hand, provides a direct measure of the dollar benefit on a present value basis that can be expected from a project.
-
Risk and Uncertainty: The Payback Period method does not consider the risk and uncertainty of future cash flows. It assumes that all cash flows are certain. NPV, however, discounts future cash flows which indirectly takes into account the risk of future cash flows.
Similar Questions
Which of the following statement is incorrect? O a. Payback period is defined as the number of years it takes for the cash flows from a project to recover the project's initialinvestment. O b.NPV method is better than payback period method in the way that NPV method accounts for the time value of moneywhereas payback period method does not. O c. In general, there can be as many lRRs as the number of times the project's cash flows change sign over time. O d. An internal rate of return (IRR) will always exist for an investment opportunity.
Activity 2: Concept Check (Payback) Q1) Which of the following statements is FALSE? A Payback period refers to the number of periods take to recover the initial investment of a project. B The payback rule is reliable because it considers the time value of money and depends on the cost of capital. C The payback rule is primarily used because of its simplicity. D The payback rule is useful in cases where the cost of making an incorrect decision might not be large enough to justify the time required for calculating the NPV. SUBMIT
The Payback Period Rule states that a company will accept a project if:
In payback method one finds out *1 pointa. the period necessary to invest the cost of the systemb. the time required for the full benefits to accruec. the time at which benefits exceed costd. whether the system is able to payback amount invested
Which is not a true statement about the disadvantages of certain methods of payment?
Upgrade your grade with Knowee
Get personalized homework help. Review tough concepts in more detail, or go deeper into your topic by exploring other relevant questions.