Writing Assignment - Middlehurst House

Net present value (NPV) is a capital investment analysis method that incorporates the time value of money and measures the net difference between the present value of an investment’s net cash inflows and the investment’s initial cost. The decision rule for net present value is:  If the net present value is positive, then invest; if the net present value is negative, do not invest. 

The accounting rate of return (ARR) is a capital investment analysis method that measures the profitability of an investment. The accounting rate of return (ARR) on an investment is calculated with the following formula:  Average annual operating income / Average amount invested.  The decision rule for accounting rate of return is:  If the expected accounting rate of return meets or exceeds the required rate of return, then invest. If it is less than the required rate of return, then do not invest.

Most companies have limited resources and have to make hard decisions about which projects to pursue and which ones to delay or reject.  These decisions are not just based on the quantitative factors of payback, accounting rate of return (ARR), net present value (NPV), profitability index, and internal rate of return (IRR). Qualitative factors must also be considered.   For example, a company may choose manufacturing equipment with a lower NPV or IRR because it is more environmentally friendly or accept a project that is not profitable but adds value to the community.  Companies should also consider the opportunity costs of rejecting certain projects and the possibility of lost business if there is negative public perception of the company’s choices.