Question

What is the usefulness of the payback and discounted payback methods? Are either of them useful for project decision making?

Answer 1

The usefulness of payback and discounted payback methods is as follows :-

1.) Payback period calculates the number of years it takes to cover the initial investment

2. Payback period is useful if the firm has limited access to additional Liquidity i.e the shorter the PB , it is better. So its a good measure to calculate liquidity.

3) Discounted payback period method uses discounted cash flows instead of actual cash flows ie number of years it must take to recover initial investment in present value terms.

Both of them are used in project decision making but dont base decisions only on PB method because it doesn't take into account time value of money, Discounted payback period addresses this by using time value of money but it still leaves Cash flow after payback period so its primarily used as a measure of liquidity.

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