Payback period refers to the time within which an amount that has been invested in an asset needs to be repaid through net cash flow that is created by the asset. This model is a simple way to assess the threats that are related to a proposed project. An invested that has a shorter payback time is preferred more than that with a more extended payback period (Hansen and Mowen, 2015). The formula employed to draw from the payback time is referred to as the payback model. It is communicated in years as well as portions of years. The formula used for this model is unsophisticated. An illustration for this can be that of an organization injecting 4500,000 dollars in a new production line which in return generates an up cash flow of 150,000 dollars annually. For such an instance, the payback time becomes 3.0 years ($ 450,000 opening investment ÷ $150,000 yearly payback). The decision rule for the payback method is that a project is only accepted if its payback time is less than the intended payback time.
The weaknesses associated with this model is that it fails to consider the time value of money and that it does not take into account the valuable life of the assets as well as cash inflow following the payback time. While the payback time model concentrates on the amount of time within which a project breaks even using ostensible dollars, the discounted payback time reflects total time required for a project to break even on the occurrence of cash flow while considering the return rate that reigns at that time in the market. This in return helps with considering the valuable life of the assets and cash flow due to the project receiving higher discounts towards the end of the project life, therefore, attracting higher discounts owing to the compound interests.
Delegate your assignment to our experts and they will do the rest.
Reference
Hansen, D. & Mowen, M. (2015). Cornerstones of cost management . Mason, OH: Cengage Learning.
