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In Capital Budgeting, what is the basic flaw of the "Payback Model

Jack:

Let's say that you invest at $5000 and the we anticipate different returns each year, such as:

year 1: $2000
year 2: $2000
year 3: $500
year 4: $500
year 5: $1000

For the payback calculation we find the total number of years in which the return is equal to your initial investment. When your initial investment is $5000, the first year you received $2000, which is less than $5000. Therefore payback does not occur in year 1.

At the end of the second years year, you have received $4000, which is still less than the initial investment, so payback does not occur in year 2.

After three years, your return totals $4500. Still less than the initial investment, so no payback yet.

After the fourth year, however, the payback finally equals the initial investment.

Here is a more detailed explanation. It's getting too late to think ...


http://www.allbusiness.com/accounting/budget/840197-1.html

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