Question 4.RQ.2: The payback method has been criticised for not taking into a...

Financial Management for Decision Makers

The payback method has been criticised for not taking into account the time value of money. Could this limitation be overcome? If so, would this method then be preferable to the NPV method?

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The payback method, in its original form, does not take account of the time value of money.
However, it would be possible to modify the payback method to accommodate this requirement.
Cash flows arising from a project could be discounted, using the cost of capital as the appropriate discount rate, in the same way as the NPV method. The discounted payback approach is used by some businesses and represents an improvement on the original approach described in the chapter. However, it retains the other flaws of the original payback approach that were discussed. For example, it ignores relevant data after the payback period. Thus, even in its modified form, the PP method cannot be regarded as superior to NPV.

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