This period is some times referred to as "the time . It is relatively easier to calculate because it needs very few inputs (Abor, 2017). The payback method is a method of evaluating a project by measuring the time it will take to recover the initial investment. or simply in a long term dicision making for the entity .and . For companies with liquidity issues, payback period serves as a good technique to select projects that payback within a limited number of years. The method is easy to explain to others. 3) Payback determines the period over which a 'payback' on a specific investment will be made. Its quick computation makes it a favorite among executives who prefer snap answers. A. It is an indication for the prospective investors specifying the payback period of their investments. The payback period method is the Payback period method. It requires less cost, time and labour when compared to other methods of capital budgeting. B1a: Impact of Depreciation Discussion regarding depreciation tax shield is correct. is a method to evaluate the project in capital budgeting . (3) This approach gives due weight to the profitability of the project. The advantages and disadvantages of NPV investment appraisal approach has been explained in detail. A. a) Accept; The discounted payback period is 2.18 years. Payback method. The concept backing the method is easy to understand. This method reduces or avoids the loss through obsolescence since shorter . Payback period method is the strategy used to calculate the amount of time that a given investment will take to recover the initial cost. II and III only. The longer a project takes to recoup its cost, the higher the risk becomes of not recouping the cost at all. The payback period is useful from a risk analysis perspective, since it gives a quick picture of the amount of time that the initial investment will be at risk. The main advantages and disadvantages of using Payback as a method of investment appraisal are as follows: Investment risk can be assessed through payback method. Which of the following are advantages of the payback method of project analysis? The payback method requires fewer inputs and is typically easier to calculate than other capital budgeting methods. Small and large companies tend to concentrate on ventures with a chance of quicker, more attractive payback. 1. Ignores the time value of money: The most serious disadvantage of the payback method is that it does not consider the time value of money. It helps determine how long it takes to recover the initial . The advantage of purchase is related immediately to their payback period. One of the biggest advantages of the payback period method is its simplicity. In most cases, a project with a shorter payback period is usually less risky. Another advantage of this method is the preference for liquidity. Describe the advantages of using the payback method Key Takeaways Key Points Payback period, as a tool of analysis, is often used because it is easy to apply and easy to understand for most individuals, regardless of academic training or field of endeavor. What are the weaknesses of the payback method? One of the biggest advantages of using the payback period method is the simplicity of it. However, payback period does not consider the time value of money, thus is less useful in making an informed decision. The payback method requires fewer inputs and is typically easier to calculate than other capital budgeting methods. Hence, it's an easy way to compare several projects and then to choose the project that has the shortest payback time. See Also: Payback Period Method Bailout Payback Method Rule of 72. Even with the more advanced methods available, management may choose to rely on this tried and true method for the sake of efficiency. The simplicity of the payback period method is one of its greatest advantages. The formula for calculating even cash flows or, in other words, the same amount of cash flow every period is: Payback Period = (Initial Investment / Net Annual Cash Inflow) Disadvantages of NPV. The calculation requires only an estimate of an investment's annual cash flows and its initial cost. Advantages: An investment project with a short payback period promises the quick inflow of cash. The pay back method of investment appraisal establishes the amount of time the investment must be held before cash receipts equal the initial investment total. It becomes easier to identify the projects that provide the fastest return on investment. In case of uncertainty in future, this method is most appropriate. Despite of the great advantages of Payback Period, it also . It helps determine the time period required by a project to break even. It is very simple to understand and easy to calculate. See also: What is the accounts receivable turnover? It incorporates the time value of money into the calculation. Investment amount not correct at 220,000. This method reduces or avoids the loss through obsolescence since shorter . Disadvantages: With the NPV method, the disadvantage is that the project size is not measured. The payback period is important for the firms for which liquidity is very important. Definition. Multiple Choice Considers time value of money, liquidity bias. What is an advantage of the payback period method? 2) NPV calculates an investment's present value, but eliminates the time element and assumes a constant discount rate over time. Advantages: The cash payback method is widely used to evaluate capital investment proposals in new projects. A company is compelled to invest in projects with shortest payback period, if capital is a constraint. A short payback period is therefore desirable. The payback period refers to the value of the period it takes to overcome the investment cost. It is very simple to understand and easy to calculate. Establishing a payback period is easier than other capital budgeting calculation methods such as internal rate of return (IRR) or net present value (NPV). 3) Payback determines the period over which a 'payback' on a specific investment will be made. The chief merits of the payback period are briefly presented below. The method is extremely simple to understand, as it only requires one straightforward calculation. There are some assumptions regarding forecasting: 1. The payback period method in capital budgeting is the selection criterion, or the key factor, on which most organizations depend to choose among possible capital projects. Advantages of Payback Period Simple to Use and Easy to Understand This is among the most significant advantages of the payback period. 2. The payback period is a method commonly used by investors, financial professionals, and corporations to calculate investment returns. The calculation requires only an estimate of an investment's annual cash flows and its initial cost. Using forecasted cash flow, you can determine how quickly an investment will pay itself back. Managers should complement payback method with other methods in order to make a sound investment decisions. On the other hand, payback method looks at the number of years which make it simple and easy to understand. Transcribed image text: Which of the following are advantages of the payback method of project analysis? It Is Simple A significant percentage of companies use employees with different backgrounds to analyze capital projects which is not only biased but a difficult process to understand. No assumptions about future interest rates. The biggest advantage of the payback period or method includes that it is simple, meaning that the . IRR is measured when you calculate the interest rate where the present value of a future cash flow equates to the required capital investment. With the NPV method, the advantage is that it is a direct measure of the dollar contribution to the stockholders. 2. (2) It gives importance to the speedy recovery of investment in capital assets. Using the payback method and reducing the . This is the simplest way to budget for a new asset. It takes into account the time value of money by deflating the cash flows using cost of capital of the company. The second project has a payback period of four years, or $40,000 investment divided by $10,000 per year of savings. An advantage of using the payback method is its simplicity. Discounted Payback Period vs Simple Payback Period As already noted, the difference between the discounted payback period method and the simple payback method is the fact that we can discount the cash flows and account for the time value of money, which as explained above is the fact that having one dollar today is not the same as having one dollar in one year from now. C. Liquidity bias, ease of use. use. It Is a Simple Process. Cash flows received during the early years of a project get a higher weight than cash flows received in later years. liquidity bias . All that you need to calculate the payback period is the project's initial cost and annual cash flows. Satisfying the shareholders needs is one of the main goals of an organization. Click to see full answer. The main advantages of payback period are as follows: A longer payback period indicates capital is tied up. It is therefore, a useful capital budgeting method for cash poor firms. Payback Period- The payback period is the most basic and simple decision tool. Advantages of Accounting Rate of Return Method. This method focuses on liquidity rather than the profitability of a product. B. 2. Disadvantages of the Payback Method. Advantages of discounted cash flow. A long payback means that the investment dollars will be locked up for a long time, hence the project is relatively illiquid, and since the project's cash flows must be forecast far out into the future, the project is probably quite risky. Internal rate of return method. Offers Quick Evaluation Besides, what is an advantage of the payback method? Futures studies evolve as a method of investigative the alternative futures and identify the majority possible. Easy to calculate. Other methods use these same inputs, but require additional assumptions that are more difficult to estimate, such as the cost . Considers time value of money, liquidity bias. A5: Payback Period Payback period calculation of 0 years and 0 months is incorrect. 3. 2. Focus on early payback can enhance liquidity Investment risk can be assessed through payback method Shorter term forecasts This is more reliable technique The calculation process is quicker than and simple than any other appraisal techniques (1) It is easy to understand, compute and communicate to others. Focus on early payback can enhance liquidity. Assuming a cost of capital that is too low will . by Get Answers Chief of LearnyVerse (231k points) 91 994 3039 answered Sep 10, 2021. 3. If you were to analyze a prospective investment using the payback method, you would tend to accept those investments having rapid payback . The sooner the cash is recovered, the sooner it becomes available to invest again in other projects. 1) NPV and payback methods measure the profitability of long-term investments. The method needs very few inputs and is relatively easier to calculate than other capital budgeting methods. Which of the following are advantages of the payback method of project analysis? Even though it suffers from some flaws, it is a good method to determine the viability of a project as it considers the time value of money. A company is compelled to invest in projects with shortest payback period, if capital is a constraint. Advantages of Payback period. It is also beneficial for those companies who are recently established and want to know the time frame in which they would recover their original investment, therefore those companies which do not want to take risk and want quick return on their investments can . Discounted Payback period = 5 year + 34,700/39,480 = 5.87 years. Easy to understand. The amount of time will help in deciding whether the . You cannot apply the payback method to these projects. Merits or Advantages of Payback Period method. (I-V) answer comment. The biggest disadvantage to the net present value method is that it requires some guesswork about the firm's cost of capital. Limitations of Payback Period Analysis. The payback period of a given investment or project is an important determinant of whether to undertake the position or project, as longer payback periods are typically not desirable for investment positions" (What is the payback, 2018, p. 1). NPV vs Payback Method. The pay back calculation divides the initial project cost by the yearly income amounts. O Ignores time value of money, ease of use. There is no means to shape what the prospect resolve be among inclusive belief. That allows the following calculation: Payback for the project arises £200,000/£450,000 through Year 4. All cash flows need revision. 1. Payback period it is simplest and quickest way to find out the capital expenditure. Advantages of Payback Period. the payback method . Click to see full answer. The payback period is useful from a risk analysis perspective, since it gives a quick picture of the amount of time that the initial investment will be at risk. Which of the following are advantages of the payback method of project analysis? Payback period is a very simple investment appraisal technique that is easy to calculate. 3. For example, a company plans to buy a new IT server for $500,000, and that server is predicted to generate $50,000 cash each year . Helps prevent cash flow problems since Money will be recovered as quickly as possible Disadvantages of Pay Back Method: Cash earned after the payback method is ignored The Advantages of the Pay Back Method of Investment Appraisal Evaluating capital investment options requires calculating the potential compensation and the risk of each project. Discounted payback is straight forward, there no special software or system requires. Payback Method Advantages and Disadvantages. Merits or Advantages of Payback Period method. Advantages of Payback Period No assumptions about future interest rates. Opting for a payback analysis makes decisions easier as the method is easy to explain to business . You base your decision on how quickly an investment is going to pay itself back, and that is done through forecasted cash flow. Net present value method. < Prev 49 of 75 !! The rigorous economic analysis is not required for this, anyone can do it. This approach has the following advantages of its own : (1) Like payback method it is also simple and easy to understand. Advantages And Disadvantages Of Payback Period. Advantages #1 - The formula is straightforward to know and calculate You simply need the initial investment and the near term money flow information. In spite of the method that we utilize around willpower forever be an component of hesitation pending the predict possibility have move towards to go by. The first is that it fails to take into account the time value of . T. Lucy (1992) on page 303 defined payback period as the period, usually expressed in years which it takes for the project's net cash inflows to recoup the original investment. Advantages And Disadvantages Of Payback Method Finance Essay Generally individuals analysis the world as consisting of a big digit of alternative. In this case, the first project has the shorter payback . The payback period is the length of time that it takes for a project to recoup its initial cost out of the cash receipts that it generates. The net present value method evaluates a capital project in terms of its financial return over a specific time period, whereas the payback method is concerned with the time that will elapse before a project repays the company's initial investment. However, it disregards the time value . Findings - The analysis show that the payback method i s preferred in appraising capital budget decisions in various organizations because of its simplicity, liquidity and risk assessment among many other advantages. To calculate the payback period, you'd take the initial $3,000 investment and divide by the cash flow per year: Since the machine will last three years, in this case the payback period is less . List of the Advantages of the Internal Rate of Return Method. O Liquidity bias, arbitrary cutoff point. Payback period (PBP) is the time (number of years) it takes for the cash flows of incomes from a particular project to cover the initial investment. The chief merits of the payback period are briefly presented below. The payback method of capital budgeting shows that the first project has a payback period of three years, or your $45,000 investment divided by $15,000 per year of savings. Advantages of Payback method: It is extremely simple It is useful where technology changes rapidly Cost of machinery is recovered before new model comes out. The advantage of using payback period is that its ease of use and anybody who is having limited financial knowledge can apply it. Advantages of Payback Period 1. The project is allowed if the payback period is less the expected time because it determines how long it needs for a company to recover its investment. However, it disregards the time value . With the IRR method, the advantage is that it shows the return on the original money invested. Payback Method Advantages and Disadvantages. It is good for screening and for fast moving environments. B1: Net Cash Flow Without Depreciation $393,750 is not correct net cash flow for year 2 without depreciation. The payback period is an effective measure of investment risk. payback method in making capital budget decisions in relation to other appraisal techniques. The payback period is important for the firms for which liquidity is very important. In case of uncertainty in future, this method is most appropriate. a) Considers time value of money, liquidity bias b) Liquidity bias, arbitrary cutoff point . The payback period formula's main advantage is the "quick and dirty" result it provides to give management some sort of rough estimate about when the project will pay back the initial investment. ( ) Liquidity bias, ease of use. 0 votes . It requires less cost, time and labour when compared to other methods of capital budgeting. 1) NPV and payback methods measure the profitability of long-term investments. Companies typically prefer a shorter payback period to minimize the risk. According to Corporate Finance Institute, the discount rate is the rate a business uses to convert future amounts into today's dollars. Other methods use these same inputs, but require additional assumptions that are more difficult to estimate, such as the cost . NPV (Net Present Value) is calculated in terms of currency while Payback method refers to the period of time required for the return on an investment to repay the total initial investment.Payback, NPV and many other measurements form a number of solutions to evaluate project value. Payback period is defined by CIMA as, " The time required for the cash inflows from a capital investment project to equal the initial cash outflows." Advantages of Pay Back Period (PBP) - = approx 23 weeks through Year 4. The discounted payback period is an upgraded capital budgeting method in comparison to the simple payback period method. There are some assumptions regarding forecasting: 1. The main advantages of payback period are as follows: A longer payback period indicates capital is tied up. Despite its appeal, the payback period analysis method has some significant drawbacks. Do it simplicity of it of LearnyVerse ( 231k points ) 91 994 3039 Sep! 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