ACCA Applied Knowledge · Management Accounting · Asset budgeting and investment appraisal
Which of the following is a limitation of the payback method of investment appraisal?
A limitation of payback is that it ignores cash flows arising after the payback period. A project with large later returns may therefore be rejected, because the method only measures the speed of recovering the initial investment.
- AIt cannot be calculated where cash flows are uneven
- BIt ignores cash flows arising after the payback periodCorrect
- CIt uses accounting profit instead of cash flows
- DIt takes account of the time value of money
Explanation
Payback only measures how fast the outlay is recovered and ignores all later cash flows, so a highly profitable long-term project may be rejected. It uses cash flows, can handle uneven flows, and does not discount in its simple form.
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