Question

the longer the time period the less reliable the payback method. Is that a true statement? If so, why? Think about the time value of money. If we have a ten year time frame versus a three year time frame will the present value of an inflow in the latter years will be more or less accurate? In addition, think about how this relates to valuing a short versus long term debt security.

With that said, honestly, are the more accurate methods (NPV and IRR) really that difficult?

Answer 1

When there is a longer payback period, it will mean that the project should not be accepted because it is taking more than normal time in repayment of it's cash outflows so always shorter payback periods are preferred.

This is a true statement because there is always a preference for the shorter payback period as cash outflows will be recovered quickly.

If we have a 10 year time frame vs 3 year time frame the present value of an inflow in the letter years would be less accurate because there is higher amount of discounting factor involved and higher depreciation in the value of money and the cash flows in the later years are not predicted easily because it is not easy to forecast the future based upon the current environment.

valuation of short term debt securities are comparatively easier than the valuation of the long-term securities because short term debt securities will be having lower amount of interest payments and duration so that discounting return can also be easily ascertained in comparison with longer securities and longer securities will have difficulty of the prediction of various economic cycle in the long run so this counting that cannot be easily ascertained.

Methods like net present value and internal rate of return are not completely accurate methods and they are also difficult while calculation because ascertainment of discount rate is not an easy task and prediction of economic cycle and risks exposures are not easy, so, it can be said that the methods of net present value and internal rate of return are not accurate and precise, and there are a lot of difficulties associated with valuing a product through these methods.