Question

In some cases, the payback reciprocal can be used to estimate the:

      a. internal rate of return

      b. accounting rate of return

      c. profitability index

      d. net present value

      e. net initial investment

Answer 1

The payback reciprocal is a crude estimate of the rate of return for a project or investment.

The payback reciprocal is computed by dividing the digit "1" by a project's payback period expressed in years.

For example, if a project's payback period is 4 years, the payback reciprocal is 1 divided by 4 = 0.25 = 25%.

This reciprocal yields an approximation of the rate of return on an investment, though only under the following circumstances:

• Annual cash flows are uniformly even over the lifetime of the investment
• The cash flows from the project will continue forever

Since it is quite unlikely that cash flows will continue uninterrupted for a long ways into the future, it is more realistic to instead evaluate a project based on the net present value method or the internal rate of return.