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Explain the payback period model and its two significant weaknesses. How does the discounted payback period...

Explain the payback period model and its two significant weaknesses. How does the discounted payback period model addresses one of the problems?

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Answer #1

Payback period model essentially measures when the initial investment made is returned back to us without discounting the money to the present. It has two limitations

1. It doesn't address the time value of money. Hence, if we get 1$ today or tomorrow it deals with them in the same manner which isn't correct.

2. It doesn't talk about the profitability of the project. We as investors aren't just worried about getting the initial investment back. We also worry about the returns we get. Hence, these aren't calculated in this model

The discounted payback model deals with the first limitation as it discounts the cash flows while applying the payback model. Hence, it is somewhat better than the payback model

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