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Explain the concept of Payback Period (PP) in capital budgeting, and how it is computed. What...

Explain the concept of Payback Period (PP) in capital budgeting, and how it is computed. What is the payback period of a project with the following cashflows (at time periods 0, 1, 2 and 3): -$50,000, $30,000, $15,000, $15,000? Under what circumstances would PP be preferred to the Net Present Value (NPV) approach. (maximum length guide: about 150 words)

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Payback period is the number of days(years) it takes an investment to be repaid. This is useful in capital budgeting analysis when time for cash payback is essential from both the firm and shareholder perspective. The payback period is calculated by taking the cumulative cash flows from Year 0 and when the cumulative cash flows become zero, the cash flows are said to be paid back.

Payback period is sometimes preferred over NPV method by managers when evaluating a long term project. While the NPV may be positive, the firm would also be interested in finding out how long the project takes to recoup the investment.

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