What is the benefit of basing strategic decisions on payback period? What problems are presented by...

What is the benefit of basing strategic decisions on payback period? What problems are presented by the use of this metric?

Expert Solution

Payback is defined as a length of time required to recover an initial investment.The shorter the payback period the better will be the opportunity for investments. The strategic decision are the long term complex decision which affects the direction of entire firm. The use of strategic decision will impart a common criteria to chose a project or make investments. It will help clients to understand the standards based on which certain investments are made. These strategic decisions will help to identify the issues regarding use of a specific payback period in a project and also to eliminate the problems arising with the use of this metric.

Although the payback period is widely used but it is not considered to be the perfect metric. Mainly two problems have been encountered with the use of this metric:

If the decision criteria to choosing a particular project is based on use of payback period then it will lead us to disregard projects that pay slower but pay more and therefore add more value to the firm.
It ignores the time value of the money. The real value of money keeps on declining as the time passes. Thus we ignore the opportunity cost of the money that we would have earned if we receive the cash earlier.

Nightingale answered 2 years ago

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