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Which of the following is a limitation of the Payback Period method?

Practice Questions

Q1
Which of the following is a limitation of the Payback Period method?
  1. It ignores cash flows after the payback period
  2. It is difficult to calculate
  3. It considers the time value of money
  4. It requires detailed cash flow projections

Questions & Step-by-Step Solutions

Which of the following is a limitation of the Payback Period method?
  • Step 1: Understand what the Payback Period method is. It is a way to measure how long it takes to recover the initial investment from cash flows.
  • Step 2: Recognize that the Payback Period only looks at cash flows that happen until the initial investment is paid back.
  • Step 3: Identify the limitation: The method does not consider any cash flows that happen after the payback period is reached.
  • Step 4: Realize that this means important future profits or losses are ignored, which can lead to poor decision-making.
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