Practice Problem – Payback Period Rule

Practice Question

Cases in Finance
Capital Budgeting
Payback Period Rule
True or False

The payback period rule ignores cash flows after the payback period, making it a potentially flawed method for capital budgeting.

Answer +
TRUE
Explanation +

The payback period rule calculates how long it takes to recover the initial investment from a project's cash flows. However, it ignores any benefits occurring after the payback period, which can result in undervaluing projects that deliver strong long-term returns. This limitation makes the method less reliable for evaluating overall project profitability compared to approaches like NPV.