Multiple Choice
Given an effective annual rate (EAR) of 14% and semiannual compounding, what is the nominal annual interest rate (APR) compounded semiannually?
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10. Time Value of Money
Time Value of Money Equations
Multiple Choice
Which one of the following methods of analysis ignores the time value of money?
A
Net Present Value (NPV)
B
Internal Rate of Return (IRR)
C
Discounted Payback Period
D
Payback Period
Verified step by step guidance1
Understand the concept of the 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. Methods that account for this principle use discounting techniques to adjust future cash flows to their present value.
Review the Net Present Value (NPV) method: NPV calculates the present value of future cash inflows and outflows by discounting them using a specific rate. This method explicitly considers the time value of money.
Examine the Internal Rate of Return (IRR) method: IRR is the discount rate at which the net present value of cash flows equals zero. Since it involves discounting cash flows, it also accounts for the time value of money.
Analyze the Discounted Payback Period method: This method calculates the time required to recover the initial investment using discounted cash flows. It incorporates the time value of money by discounting future cash flows.
Understand the Payback Period method: Unlike the other methods, the Payback Period calculates the time required to recover the initial investment without discounting future cash flows. Therefore, it ignores the time value of money, making it the correct answer to the question.
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