Which limitation is associated with the payback period method?

The payback period method is primarily concerned with how quickly an investment can recoup its initial outlay. However, one of its significant limitations is that it does not consider the degree of uncertainty associated with future cash flows. This means that while a project might pay back its initial investment quickly, it does not account for the risks involved or the changes in cash flows that could occur later in the project’s life.

Investors often want to understand not just how quickly they can get their money back, but also how uncertain or stable those cash flows are over the project’s duration. The payback period ignores both the timing of cash flows after the payback period and the potential variability of those cash flows. For instance, two projects might have the same payback period, but one could carry substantially more risk than the other after the payback is achieved.

By focusing solely on the return of the initial investment without assessing risk, the payback period can lead to inadequate decision-making. In contrast, methods such as NPV or IRR take into account the time value of money and project risks, which helps in making more informed investment decisions.