All 34 Capital Budgeting questions
More in Capital Budgeting
What are the advantages and disadvantages of the payback method? What is a hurdle rate? What is the difference between mutually exclusive and independent projects? What is the difference between a screening and a preference decision? What is Net Present Value (NPV) and how do you interpret it? What is the Internal Rate of Return (IRR)? What is the discounted payback period? What cash flows are relevant in capital budgeting? What is capital rationing? What is the role of residual (terminal) value in appraisal?
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Budgeting & Forecasting › Capital Budgeting

What is the time value of money and why does it matter in capital budgeting?

Intermediate

Answer

The time value of money is the principle that a sum today is worth more than the same sum in the future because it can be invested to earn returns (and due to inflation and risk). Capital budgeting spans years, so future cash flows must be discounted to present value to compare them fairly—underpinning NPV and IRR.
PV = Future cash flow / (1 + r)^n.
Real-world example $1,000 received in 3 years is discounted to its lower present value before comparing to today's outlay.

Common follow-ups: Why discount future cash flows? | Which methods use it?

Capital Budgeting Capital Budgeting Cash Budgeting
All 34 Capital Budgeting questions