Question

What are the three potential flaws with the regular payback method?  Why do companies use the payback method?

Answer 1

Three flaws of regular payback method.
1. doesn’t consider cash flows after Payback period.The cash flows after payback period also needs to be considered especially with projects where cash flows increases towards the end. Regular Payback method might lead to cancellation of high NPV project too.
2. It does not include time value of money. It provides equal weights to all the cash flow which is faulty.
3. Regular Payback method might lead to cancellation of high NPV project too and have accept project which have low NPV.

Companies use payback method because it is  easy to calculate and less time consuming to calculate.

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