Capital budgeting analysis

Advantages of the Payback Period

1. 
   Easy to understand.
   
2. 
   Adjusts for uncertainty of later cash flows.
   
3. 
   Biased toward liquidity
   

Disadvantages of the Payback Period

1. 
   Ignores the time value of money.
   
2. 
   Requires an arbitrary cutoff point.
   
3. 
   Ignores cash flows beyond the cutoff date.
   
4. 
   Biased against long-term projects, such as research and development, and new projects.
   

2. 
   Discounted payback
   

The discounted payback period is the length of time until the sum of the discounted cash flows is equal to the initial investment.

An investment is acceptable if its discounted payback is less than some pre-specified number of years.

Payback period = Full years before recovery + Unrecovered cost at the start of the year
Cash flow during the year