From the course: Accounting Foundations: Managerial Accounting

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Discounting cash flows

Discounting cash flows

From the course: Accounting Foundations: Managerial Accounting

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Discounting cash flows

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- Because capital decisions typically involve a longer period of time, we will need to factor the time value of money into those decisions. Money left idle will not earn interest from the bank, nor will it earn the potentially higher returns it can be obtained from investments in corporate stocks and bonds or real estate for example. Because money has value over time, the timing of expected cash flows is important in investment decisions. An investment made today will not generate cash inflows until the future, either periodically over a number of years or in a lump sum several years hence. Thus, for the comparison of cash flows to be accurate, all amounts should be stated at their value at one point in time, generally the present. This means that all future cash flows should be stated in terms of their present value. The mathematical process of adjusting future cash flows to their present values is called discounting. The choice of the correct interest rate or discount rate to use…

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