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The period of time required to recover the net investment is called payback period, PB.
The project which pays back the initial investment in the smallest period is acceptable under this method.
If (calculated PB < standard PB) => Accept the project
If (calculated PB > standard PB) => Reject the project
Merits of payback period:
ü Easy to understand and inexpensive to use.
ü Easy and crude way to analyze the risk.
ü Uses all cash flow information.
ü Considers liquidity.
û Ignores the time value of money.
û Ignores cash flow occurring after payback period.
û Not objective way to determine the standard payback period.
û Not a measure of profitability.
û Payback period ignores the wealth maximization.
Types of Payback period:
- 1. Simple payback period
- 2. Discounted payback period