David,
The classic reason why following the Payback Period (PB) result is bad is
that it encourages short termism: the decision rule for theoretical
discussions of PB is the shorter it is the better. What this means is that
management becomes focused on projects that are efficient in terms of
generating cash but not necessarily in terms of long term optimality.
Moreover, since the PB method has the most significant fault of ignoring
anything that happens after the PB has been reached (otherwise it would be
the PB(ish) method!), a project can be undertaken that pays back after, say,
two years ... everyone is happy ... the project continues ... the rot sets
in and cash flows become negative, or certainly take a nose dive, and over
the life of the project, long term survival is now a problem even though it
might have had a PB star rating. Of course, you could argue for abandonment
and/or sell off as a going concern, after PB if that's possible; but then
other considerations come into play.
PB ignores the time value of money, as you well know, so in the case of
projects that have long PBs, an undiscounted PB will probably give a
distorted view of a project or projects.
Just a few reasons to through into the ring for being cautious with the PB.
Duncan
----- Original Message -----
From: "David Lewis" <[log in to unmask]>
To: <[log in to unmask]>
Sent: Wednesday, November 14, 2001 8:55 PM
Subject: Re: AQA a2 business 13.7 understanding criterion levels
> ----- Original Message -----
> From: Duncan Williamson <[log in to unmask]>
> To: <[log in to unmask]>
> Sent: Friday, November 09, 2001 4:10 PM
> Subject: Re: AQA a2 business 13.7 understanding criterion levels
>
>
> > David
> >
> > This is not meant to be picky: do you also get them to discuss why a
> payback
> > of less than the target can be a BAD thing, too?
> >
> > Duncan
> >
>
> Actually I don't.
> At the risk of appearing thick, when might that be the case?
>
> Thanks
>
> David
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