Week 8 Payback Period Method

Payback Period Method

This method allows you to check how long the proposed investment takes to pay back your initial investment. You accept the project if it meets your payback requirements

Example: For the plastic extruder project:

• Note that the initial investment is recouped at the end of year 6
• If the rule in your business was to accept projects that pay back their investments within seven years (for example), you would accept this project according to the payback period method. If the rule in your business was to only accept projects that pay back their investments within four years, however, you would reject this project.

Problems with the Payback Period Method:

1. It ignores cash flows after the payback period (for example, suppose the plastic extruder project yielded $1,000,000 in year 7? If your rule was to only accept projects that paid back their investment within 5 years, you would still reject the plastic extruder project)
2. It ignores Time Value of Money concepts; assuming a dollar to be received in the future is worth just as much as a dollar today.
3. It doesn't do a very good job of comparing projects of unequal sizes (again, because all it measures is the time it takes to pay back the initial investment).