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The drawbacks of the payback approach are as follows
- Payback ignores the overall profitability of a project by ignoring post payback cash flows. In the illustration above the cash flows between 3.5 years as well as the end of the project sum to $80000. To overlook such substantial cash flows is somewhat naïve and as a consequence the method is biased in favour of fast return investments. This can be result in investments which generate cash flows more gradually in the early years but which are overall more profitable being rejected if the payback system is used for investment decisions.
- As among ARR the method ignores the time value of money.
- The payback method in the similar way as ARR offers no objective measure of what is the desirable return as measured by the length of the payback period.
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