Time Value of Money:
Learning Objectives:
- Explain the concept of time value of
money.
- Why time value of money concept is
important in capital budgeting analysis?
Explanation of of the Concept of Time Value of Money
Investments commonly involve returns that
extend over fairly long period of time.
Therefore, in approaching capital
budgeting decisions, it is necessary to employ techniques that recognize the
time value of money.
"A
dollar today is worth more than a dollar a year from now"
The same concept applies in
choosing between investment projects. Those projects that promise earlier
returns are preferable to those that promise later retunes. The capital
budgeting techniques that recognize the above two characteristics of
business investments most fully are those that involve discounted cash flow.
Two approaches to making capital budgeting decisions use discounted cash
flows. One is the
net present value method
and other is
internal rate of return method.
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