Fv

Therefore, \$1,000 a year from now is worth only \$909 today. If the interest rate, k, is known to be 10%, then you should not invest more than \$909 to get the \$1,000 return a year from now. However, if you could purchase this investment for \$875, your interest rate would be more than 10%.

Discounting cash flows to the present for comparison purposes is a viable way to assess the value of an investment. As an example, you have a choice between two investments. Investment A will generate \$100,000 two years from now and investment B will generate \$110,000 three years from now. If the cost of capital is 15%, which investment is better?

Using the formula for discounted cash flow, we find that:

This implies that a return of \$100,000 in two years is worth more to the firm than a \$110,000 return three years from now.

14.24 NET PRESENT VALUE (NPV)

The net present value (NPV) method is a sophisticated capital budgeting technique that equates the discounted cash flows against the initial investment. Mathematically, 