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Net Present Value (NPV) is a better indicator than Payback Period (PBP) because it tells precisely which value would be earned by the investors if they decide to undertake it. In general, NPV as an investment appraisal method is based on the idea that the project would be beneficial if the sum of cash coming in is greater than the sum of outflows (Weetman, 2019). Thus, it deducts invested capital from the sum of future cash inflows (in its present value).
Unlike PBP, NPV considers cash flow until the projects finish and the time value of money (shows future cash flows in todays dollars). In contrast, PBP neglects the projects overall profitability considering only cash flows within the payback period (Kagan, 2020). If the present value of future cash is more significant than the present initial investment (NPV > 0), benefits outweigh the costs, and one should invest. For that reason, it is a more reliable and more fundamental indicator than PBP. It is better to use NPV together with IRR (internal rate of return).
References
Kagan, J. (2020). Payback period. Investopedia. Web.
Weetman, P. (2019). Financial and management accounting (8th ed.). Pearson.
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