Question

Explain why managers can use the payback approach to advance their own interests at the expense of the stockholders.

Answer 1

Some projects add up to size of the company without adding value to the shareholders. A large sized company is beneficial for managers as they can get remuneration increase citing more managerial work. Hence the managers usually like to invest in the projects that would increase their remuneration. Now payback method may pass the project for the company, however the project has to be evaluated with NPV nad IRR methods too. It needs to be done in order to check whether the project really adds up value to the firm. using only payback can be misleading as it does not considers discounting of future cash flows to present. A better way would be to use discounted payback period.