15.5 Non-discounted methods: payback period

Question 1

What is the “payback period” of a project?

Answer 1

The number of years it tales a project to recover the original investment.

Question 2

How is the payback period of a project calculated?

Answer 2

[Original cost of investment or initial cash outflows] / [Annual Cash Inflows]

Question 3

What is the “Decision Rule” in the paypack method of project appraisal?

Answer 3

A project is accepted when it pays back the original investment within the specified time period (as set by the company). When choosing between multiple projects, the one with the fastest payback should be chosen.

Question 4

What are the advantages of the payback period method of project appraisal?

Answer 4

• it uses cash flow, not profit
• it is simple to calculate
• it is adaptable to changing needs
• encourages quick return and fast growth
• useful for situations such as rapidly changing technology
• maximises liquidity

Question 5

What are the disadvantages of the payback period method of project appraisal?

Answer 5

• ignores cash flows after the payback period
• very subjective
• ignores the timings of cash flows
• ignores profitability