Advantages of Payback
Payback is a popular investment criterion in practice. It is considered to have certain virtues.
- Simplicity. The most significant merit of payback is that it is simple to understand and easy to calculate. The business executives consider the simplicity of method as a virtue. This is evident from their heavy reliance on it for appraising investment proposals in practice.
- Cost effective. Payback method costs less than most of the sophisticated techniques that require a lot of the analysts’ time and the use of computers.
- Short term effect. An investor can have more favorable short term effects on earnings per share by setting up a shorter standard payback period. It should, however, be remembered that this may not be a wise long term policy as the investor may have to sacrifice its future growth for current earnings.
- Risk shield. The risk of the project can be talked by having a shorter standard payback period as it may ensure guarantee against loss. An investor has to invest in many projects where the cash inflows are and life expectancies are highly uncertain. Under such circumstances, payback may become important, not as much as a measure of profitability but as a means of establishing an upper bound on the acceptable degree of risk.
- Liquidity. The emphasis in payback is on the early recovery of the investment. Thus, it gives an insight into the liquidity of the project. The funds so released can be put to other uses.
