Multiple Choice
If the five-year discount factor is \(d\), which of the following expressions correctly represents the present value (PV) of \$1$ to be received in five years?
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10. Time Value of Money
Time Value of Money Equations
Multiple Choice
Which of the following investment criteria takes the time value of money into consideration?
A
Payback Period
B
Return on Investment (ROI)
C
Accounting Rate of Return (ARR)
D
Net Present Value (NPV)
Verified step by step guidance1
Understand the concept of time value of money: The time value of money is the principle that a dollar today is worth more than a dollar in the future due to its potential earning capacity. This concept is crucial in evaluating investment decisions.
Review the investment criteria provided: Payback Period, Return on Investment (ROI), Accounting Rate of Return (ARR), and Net Present Value (NPV). Determine which of these methods incorporates the time value of money.
Analyze Payback Period: This method calculates the time required to recover the initial investment but does not account for the time value of money. It treats all cash flows equally, regardless of when they occur.
Evaluate ROI and ARR: Both Return on Investment (ROI) and Accounting Rate of Return (ARR) focus on profitability metrics but do not discount future cash flows to account for the time value of money.
Examine Net Present Value (NPV): NPV explicitly incorporates the time value of money by discounting future cash flows to their present value using a discount rate. This makes NPV the correct answer for investment criteria that consider the time value of money.
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