The payback method of investment appraisal: A review and synthesis

Abstract

The payback (PB) method of investment appraisal has been the subject of considerable comment and criticism in the literature. This paper draws together some of those important literature contributions and the results from published UK and USA ‘survey’ reports over the past twenty-five years. While many of the surveys have reported an increasing use of the discounted cash flow financial appraisal methods, this has not totally been at the expense of the PB which continues to be a popular method used in industry. PB has been shown to be a traditional, popular, primary, and important method in both the UK and USA. The use of PB has been shown to be positively related to capital budget size. However, the importance of PB was seen to be inversely related to capital budget size. The use of PB has been shown by some researchers to be positively related to firm size, while other researchers have reported that its use is inversely related to firm size. However, it has also been concluded that the use of PB was not significantly influenced by firm size. PB has been shown to be less used for strategically important projects than routine replacement projects in moderately sized USA firms, while on the other hand it has been shown to be an important method used in the appraisal of advanced manufacturing technology (AMT) projects in both the UK and USA. This paper reviews the PB method of investment appraisal as used in industry, first as a technique, identifying two of its main disadvantages and then commenting on the discounted payback method. Evidence showing that the PB acts in a supportive role to the sophisticted DCF methods is presented and the following topics are discussed in detail; PB and owner-manager conflict; as a constraint; in its communication role; as a reciprocal of the internal rate of return; as a proxy for a projects duration; and PB and AMT projects. Following the conclusions, recommendations for further research are proposed.