The Role of Payback in the Investment Process

Abstract This study examines the use of the payback (PB) method as a means of evaluating a proposed asset's risk and its joint application with profit-oriented capital budgeting models. Previous research studies indicating a linkage between the PB method and risk analysis are reviewed. A certainty-equivalent model is used to demonstrate this relationship and the properties of the relationship exploited by PB when used as a heuristic. Results of the analysis indicate that using a hurdle PB as a filter for identifying proposals with acceptable risk and return attributes is consistent with more quantitatively oriented investment techniques under certain conditions. The study then examines the conceptual relationship between PB and profit-oriented capital budgeting models. Results suggest that PB and profit-oriented capital budgeting techniques measure different attributes of an investment and complement one another in describing and analysing its cash flows.

[1]  Owner—Manager Conflict and the Role of the Payback Method , 1985 .

[2]  Ross L. Watts,et al.  Incentive and Tax Effects of Executive Compensation Plans , 1982 .

[3]  R. Pike,et al.  A Review of Recent Trends in Formal Capital Budgeting Processes , 1983 .

[4]  David F. Scott,et al.  The Capital Expenditure Decision-Making Process of Large Corporations , 1975 .

[5]  Lawrence J. Gitman,et al.  A Survey of Capital Budgeting Techniques Used by Major U.S. Firms , 1977 .

[6]  W. L. Beedles.  ON THE USE OF CERTAINTY EQUIVALENT FACTORS AS RISK PROXIES , 1978 .

[7]  M. Statman.  The Persistence of the Payback Method: A Principal-Agent Perspective , 1981 .

[8]  Gary L. Sundem,et al.  SURVEY AND ANALYSIS OF CAPITAL BUDGETING METHODS , 1978 .

[9]  Payback: A Maligned Method of Asset Ranking? , 1979 .

[10]  Lawrence A. Gordon,et al.  Sophisticated capital budgeting selection techniques and firm performance , 1985 .

[11]  M. Gordon.  The Payoff Period and the Rate of Profit , 1955 .

[12]  H. Martin Weingartner,et al.  Some New Views on the Payback Period and Capital Budgeting Decisions , 1969 .

[13]  A. A. Robichek,et al.  CONCEPTUAL PROBLEMS IN THE USE OF RISK‐ADJUSTED DISCOUNT RATES* , 1966 .

[14]  Merton H. Miller,et al.  DEBT AND TAXES , 1977 .

[15]  Van Horne,et al.  Financial Management and Policy , 1968 .

[16]  T. Klammer,et al.  Empirical Evidence of the Adoption of Sophisticated Capital Budgeting Techniques , 1972 .

[17]  R. Pike.  THE CAPITAL BUDGETING BEHAVIOUR AND CORPORATE CHARACTERISTICS OF CAPITAL‐CONSTRAINED FIRMS , 1983 .

[18]  Sasson Bar-Yosef,et al.  ON SOME DEFINITIONAL PROBLEMS WITH THE METHOD OF CERTAINTY EQUIVALENTS , 1977 .

[19]  Gary L. Sundem.  EVALUATING CAPITAL BUDGETING MODELS IN SIMULATED ENVIRONMENTS , 1975 .

[20]  Gary L. Sundem,et al.  Capital Budgeting Methods and Risk: A Further Analysis , 1980 .