Final answer:
The payback period method's weaknesses include ignoring the time value of money, cash flows after the payback period, and the risk level of investments. Present discounted value offers a more comprehensive analysis.
Step-by-step explanation:
The payback period method is commonly used by businesses to evaluate proposed investments by calculating the time it takes for earnings to cover investment costs. However, this method has several weaknesses:
- It does not consider the time value of money, which means it ignores the fact that money available today is worth more than the same amount in the future due to its potential earning capacity. This makes present discounted value a more comprehensive tool for evaluating investment opportunities.
- The payback period method also ignores cash flows that occur after the payback period, which could lead to neglecting profitable long-term investments.
- It does not account for the risk level of the investment or the varying cost of capital, which can inaccurately represent the return of an investment.
To accurately assess long-term profitability and sustainability, tools such as the present discounted value should be used, providing a broader analysis that accounts for future cash flows and the time value of money.