Discuss the principal limitations of the cash payback method for evaluating capital investment proposals.

Limitations :

1.  ignores cash flows after payback period

2. ignores the worth of those cashflows over time

Explanation:

Payback Period is the length of time required for the total cash inflows to equal the initial capital investment.

In principle, the sooner the capital expenditure is recouped (paid back) the better and the more attractive the project is. Whilst the longer the period the less attractive the project is.

However, payback method ignores the fact that some projects in their initial phases start with little cash inflows which at a later stage increase significantly. Thus this method ignores cash flows after payback period. Also, this method ignores the worth of those cashflows over time ( ignores time value of money) for a dollar today is worth more than a dollar tomorrow.

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