Payback Period is the time required to recover the initial investment in a project. it refers to the length of the duration required to recover the initial cost of the project. In other words, it is defined as the number of years required to recover the initial investment from the accumulated cash flows.
ADVANTAGES OF PAYBACK PERIOD
- It is very simple and easy to operate, not only in concepts even in its practical applications.
- It shows the liquidity position of the firm.
- It helps in finding out risky proposals by assigning lower priority to the risky proposals.
- The projects with short payback period is very less risky when compared to longest payback period projects.
DISADVANTAGES OF PAYBACK PERIOD
- It ignores the time value of money i.e. It give equal weights to all cash inflows.
- It ignores the cash flows after completion of payback period.
- It ignores scrap value and economic life of the project.
- The payback period is simply considered as capital recovery.
ACCEPT AND REJECT CRITERIA FOR PAYBACK PERIOD
If the actual payback period is less than the pre-determined payback period, the project would be accepted and if not, it would be rejected.