Which metric discounts future cash flows to determine value today?

Which metric discounts future cash flows to determine value today?

• A. Net Present Value
• B. Payback Period
• C. Internal Rate of Return
• D. Accounting Profit

Answer: (A)

Discounting future cash flows to present value is the idea behind measuring how much an investment is worth today. Net Present Value does this by taking each expected future cash flow, applying a discount rate to convert it into its value in today’s dollars, summing those present values, and then subtracting the initial investment. The result is a single present-day value that tells you whether the project adds value given the chosen rate. If this net value is positive, the investment is considered worthwhile in today’s terms; if negative, it isn’t. Other metrics don’t measure present value in the same way. The payback period looks at how long it takes to recover the initial cost and ignores money's time value after that point. Accounting profit is based on accrual accounting and doesn’t reflect actual cash flows or discount to present value. Internal rate of return does involve discounting to find a break-even rate, but its output is a percentage, not the present value itself, so it doesn’t directly state the value today.

Discounting future cash flows to present value is the idea behind measuring how much an investment is worth today. Net Present Value does this by taking each expected future cash flow, applying a discount rate to convert it into its value in today’s dollars, summing those present values, and then subtracting the initial investment. The result is a single present-day value that tells you whether the project adds value given the chosen rate. If this net value is positive, the investment is considered worthwhile in today’s terms; if negative, it isn’t.

Other metrics don’t measure present value in the same way. The payback period looks at how long it takes to recover the initial cost and ignores money's time value after that point. Accounting profit is based on accrual accounting and doesn’t reflect actual cash flows or discount to present value. Internal rate of return does involve discounting to find a break-even rate, but its output is a percentage, not the present value itself, so it doesn’t directly state the value today.