Utilizing the Time Value of Money Essay Example | Topics and Well Written Essays - 500 words

Utilizing the Time Value of Money - Essay ExampleBut do to virtually limitations of these tools other tools such as Profitability Index and Payback Period. The payback period determines the duration of the term it would take to recover the investment made initially. This will give us the number of periods it would take to breakeven for the initial investment made. The profitability index is used as well in investment decisions because it measures the value created per vaulting horse invested. So if the PI shows a greater than 1 value, then it means that the investment is returning a greater amount than invested. These two techniques ar used because they resolve the disadvantages of NPV and IRR methods. (Helmkamp, 1990)The first disadvantage of a NPV count is its dependency on the interest/ bank discount calculates. It is very difficult for the investor to know the correct discount rate since they can change though out the life of that investment making considerable differences on the decision. (Investopedia, 2008) other issue with the discount rate is the differences in the risk factor of the investment. Since the risk can change, therefore the discount rate, this can make lives very hard in calculating NPV. (Investopedia, 2008)Another disadvantage lies in the facts that NPVs are just mathematics calculations that do not take into account the real options available for investment.