Payback period limitations: which statement is true?

• A. It accounts for post-payback cash flows
• B. It ignores the time value of money and post-payback cash flows
• C. It considers opportunity costs
• D. It ignores cash flows entirely after payback

Answer: (B)

Payback period is a simple measure of how long it takes to recover the initial investment from cash inflows. A major limitation is that it ignores the time value of money, meaning it doesn’t discount future cash flows to their present value. It also ignores any cash flows that occur after the investment has been recovered, so it doesn’t reflect the project’s overall profitability or risk beyond the break-even point. Because of these two gaps, the statement that the payback period ignores the time value of money and post-payback cash flows is true—the standard method treats all dollars the same regardless of when they arrive and stops counting after payback. The other ideas don’t fit with the standard payback approach: it doesn’t account for post-payback cash flows, and it doesn’t explicitly incorporate opportunity costs in its basic calculation.