Why Should Managers Like Payback Period?

Abstract

Most companies use payback period in capital budgeting though it is often criticized lack of the concept of time value of money. Why should people like payback period so much? I list literature and illustrate models of both constant cash flows and stochastic cash flows. In these two models, payback period method is equivalent to the IRR method. In addition, payback is related to the duration of future cash flows so it serves as a good proxy to describe liquidity and risk when cash flows are constant. Hence, finance and accounting textbooks have to be revised to address the importance of payback and its relation to other finance indicators.