Capital budgeting – Limits of the payback method: Which statement correctly describes a limitation/feature of the simple payback approach for measuring return on investment (ROI)?

Introduction / Context:The payback method is popular in process industries for rapid screening of projects. However, it is not a comprehensive measure of profitability or value creation. Understanding its limitations prevents incorrect go/no-go decisions.

Given Data / Assumptions:

• Simple (undiscounted) payback is considered.
• Projects produce annual net cash inflows after startup.
• No tax, financing, or inflation effects are included in the definition.

Concept / Approach:Payback measures the time to recover initial investment but ignores the time value of money and does not provide a rate-based return like internal rate of return (IRR). It also ignores cash flows occurring after the payback moment, which can distort comparisons among projects with different tails.

Step-by-Step Solution:Check each statement against the definition of simple payback.Payback does not discount future cash flows, so it does not yield a discounted rate of return → statement (c) is true.It emphasizes, not underemphasizes, liquidity (so b is false).It ignores post-payback inflows (so d is false).It does not provide a full profitability picture (so a is false).

Verification / Alternative check:Compare a short-payback/low-profit project with a longer-payback/high-NPV project. Payback can favor the former even if the latter creates more value when discounted cash flow is considered.

Why Other Options Are Wrong:

• (a) Profitability requires NPV/IRR; payback alone is insufficient.
• (b) Payback actually favors early cash flows (high liquidity).
• (d) By definition, payback truncates analysis after recovery.

Common Pitfalls:Using payback as the sole decision criterion; ignoring that two projects with the same payback can have vastly different NPVs.

Final Answer:It does not measure the discounted rate of return.