Question

An advantage in a previous response to the below was risk can be identified during the payback period approach of captial budgeting. My questions is what types of risks?

According to this assignment question, an advantage was noted that risk can be identified, what types of risks.

• Describe the payback period approach to capital budgeting.
  • Explain 1 advantage and 1 disadvantage of the technique.
• Explain why it would be wise for a financial manager to learn more advanced capital budgeting techniques.

Answer 1

It is talking about different types of risk.

Payback period refers to the time period an investement takes to recover the cost.

For example :-

You have made investment of $1000 in machine A. Payback period of the same is 5-years .

Now, you have made investment of same amount in Machine B. Payback period of machine B is 3-years.

Which investment is safe?

Machine B,because it has shorter payback period.

Why ?

Because :-

Quick payback period will diminishes the market risk of making investment. It will rapidly flow cash flows and revenue in business.

See ,future is uncertain. You can try to make your best guess to find the attractiveness of a investment. But you cannot predict this accurately , you can only try to reduce that uncertainity .Machine A has longer payback period it means that more is the uncertainity as compared to Machine B.