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ACCA Applied Skills · Financial Management · Adjusting for risk and uncertainty in investment appraisal

Which of the following is a recognised weakness of using the payback period as the only method of investment appraisal?

Payback ignores cash flows arising after the payback point. It only measures how quickly the outlay is recovered, so a project with large later returns may be rejected, and it does not require a cost of capital or use accounting profits.

  1. AIt ignores cash flows arising after the payback pointCorrect
  2. BIt requires a cost of capital to be estimated
  3. CIt uses accounting profits rather than cash flows
  4. DIt favours projects with long-term returns

Explanation

Payback measures only the time to recover the initial outlay, so cash flows beyond that point are ignored. Undiscounted payback does not need a cost of capital and uses cash flows, not profits. It favours quick-return projects rather than long-term ones.

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