Chapter 12, Problem 3DQ

Summary Introduction

To explain: The weakness of the payback period.

Introduction:

Pay-back period (PBP):

It is one of the methods of capital budgeting that helps evaluate the time period in which the amount of initial investment is recovered. The formula for the calculation of PBP is shown below:

$\text{Pay-Back Period}=\text{Year}+\frac{\text{Initial Investment}-\text{Cumulative Cash Flow}}{\text{Cash FLow}}$

Where,

Year = The year in which cumulative cash flow is near and less than the initial investment.

Initial investment = The amount of the investment.

Cumulative cash flow = The cumulative cash flow which is near and less than the initial investment.

Cash flow = The cash flow of the next year from the “Year� used for the calculation.