Multiple Choice
A series of equal cash flows at fixed intervals is termed a(n):
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10. Time Value of Money
Time Value of Money Equations
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Future cash flows expected from investment projects should be:
A
Discounted to their present value using an appropriate discount rate.
B
Multiplied by the inflation rate to estimate their future value.
C
Ignored when evaluating investment projects.
D
Summed without any adjustment for the time value of money.
Verified step by step guidance1
Understand the concept of 'time value of money,' which states that money available today is worth more than the same amount in the future due to its earning potential.
Recognize that future cash flows from investment projects need to be adjusted to reflect their present value, as this allows for a fair comparison of cash flows occurring at different times.
Identify the appropriate discount rate, which is typically based on the cost of capital, risk level, or required rate of return for the investment project.
Apply the formula for present value: \( PV = \frac{FV}{(1 + r)^n} \), where \( PV \) is the present value, \( FV \) is the future value, \( r \) is the discount rate, and \( n \) is the number of periods.
Discount each future cash flow to its present value using the formula above, then sum all discounted cash flows to evaluate the investment project.
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