Multiple Choice
Money is considered to have a time value because:
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10. Time Value of Money
Time Value of Money Equations
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Calculating the present value of a future cash flow to determine its worth today is commonly called:
A
Discounting
B
Amortization
C
Accrual
D
Compounding
Verified step by step guidance1
Understand the concept of present value: Present value is the current worth of a future sum of money or stream of cash flows, given a specified rate of return. It is a fundamental concept in financial accounting and is used to evaluate the value of future cash flows in today's terms.
Identify the correct term: The process of calculating the present value involves reducing the future cash flow by a discount rate to account for the time value of money. This process is known as 'Discounting.'
Differentiate between the options: Amortization refers to the gradual reduction of a debt or asset value over time, accrual refers to recognizing revenues and expenses when they are incurred regardless of cash flow, and compounding refers to the process of growing a sum of money over time through interest accumulation. None of these terms describe the process of calculating present value.
Relate discounting to the formula: The formula for present value is typically expressed as \( PV = \frac{FV}{(1 + r)^n} \), where \( PV \) is the present value, \( FV \) is the future value, \( r \) is the discount rate, and \( n \) is the number of periods.
Conclude the correct answer: Based on the explanation and differentiation, the correct term for calculating the present value of a future cash flow is 'Discounting.'
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