Question

Why are the payback and discounted payback measures often calculated when we know they are inferior to other methods in the capital budgeting process? Explain fully.

Answer 1

Payback and discounted payback methods are more often used by decison makers when they like to know with in how many periods an investment is paid back. This is important in understanding the time a project pays back the cost incurred doe meeting the projects. In an inflationary environment every cash inflow delayed by an year can reduce the value of the project. The earlier the cash flow is brought in., lesser is the uncertainty associated and better is the project feasibility decision. A longer payback period would sometimes increase the project uncertainty and corresponding valuation due to timing of cash flows. Hence timing of cash flows is as important than the value of these cash flows.