Understanding the Concepts - Essay Example

A negative NPV means that the investment has limited chances of accessing its investment capital. NPV is the best approach that an investor can use to determine whether a certain project will be profitable or not. The payback rule is a method that tells the investor the amount of time that a project will take before it recaptures the cost of investment. This does not take into account the time value of money. In addition, cash inflows after the investment cost is recovered are not considered. Moreover, the value the project will offer to the shareholders is not considered when using payback rule (Rudolf, 2008).

When comparing NPV and payback rule it has to be noted that NPV takes into consideration assessing of new investments and comparing them with the other investment alternatives. At the end of the day, the investment that presents the highest net present value is the one that the investor has to go for. This will ensure that the investor gets the highest return from the project. Net present value method is an easy process that presents straightforward explanation of the investment capital value because it expresses it in monetary units.

Another advantage is the possibility of adapting the discount rates for different periods. The investment with the highest NPV is what is most preferred by any investor who wants to stay in the competitive world of business. NPV offers an easy way of interpreting investment because it assigns monetary units on the capital value (Rudolf, 2008). On the other hand, payback rule gives the time that an investment will get back the invested capital without assigning any monetary units to the capital.

The investment that offers the shortest payback time is the most preferred by the investors. Comparison of alternatives is possible when using the payback rule because it is used to assess the risks of the investment. This method is highly applicable in large companies, which do