Page 94 - 5.2 i. Manac Finance ITC Summarised Notes

CAPITAL INVESTMENT APPRAISAL

Payback Period

• Projects with lower payback periods are preferable (less risk).
• Where 2 projects are mutually exclusive (only one can be accepted) the one with the
lower payback period is preferred.

• If 2 projects are independent, both may be accepted, provided they satisfy the maximum
payback period acceptable to the company.

Advantages:

• Easy to calculate and understand
• Uses cash flows

• Gives a measure of risk exposure (time required before investment will be repaid)
Disadvantages:

• Time value of money and inflation are ignored (this results in the actual payback period
being longer than calculated – see discounted payback period example)

• Allowable payback term subjective

• Ignores cash received after the payback period

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