Q11RQ - Horngren'S Financial And Managerial Accounting

Question

What are some criticisms of the payback method?

Step-by-Step Solution

Answer

Answer

The payback method ignores the time value of money.

Step 1: Meaning of Payback

The payback period is the time it takes for a trade to recover its initial investment. The project with the shortest payback period is the most appealing. The loan with the shortest payback time is the most appealing.

Step 2: Some criticisms of the payback method

The payback approach is criticized for ignoring the time value of money, focusing solely on time it takes to recoup an investment instead of profitability, and ignoring any cash flows that happen beyond the payback period.