Time Value of Money Simulation Essay Example

present value and internal rate of return, are usually preferred for these reasons. However, net present value also has drawbacks, one of which is its sensitivity to discount rates.

Any fluctuation in the discount rate will impact the final outcome of the net present value (NPV). Furthermore, NPV does not take into consideration the value of any real options embedded in the investment project. The cost of capital plays a crucial role in connecting an organization's long-term investment decisions with the wealth of the owners, as determined by investors in the marketplace (Gitman, 2006). Therefore, changes in the cost of capital directly influence investment decisions. The measurement of cost of capital is primarily used to analyze potential financial risks associated with investments and to assess the minimum return required to cover the organization's financial obligations while meeting shareholder demands. By considering the costs of both debt and equity, an organization can make forecasts regarding whether the return on capital will surpass the cost of capital. If the cost of capital exceeds the return, the investment will have a significant impact on the organization's financial obligations and will impede its NPV, ultimately leading to negative effects on stock prices.