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Time Value of Money – Multiple Cash Flows

Executive summary

Investors can use the cash discounting/compounding formula to compare two or more investment opportunities with cash flows occurring over the same time period.

Key learning objectives:

  • How can investors use the cash discounting formula to compare investments? What are its limitations?

How can investors use the cash discounting formula to compare investments? What are its limitations?

Investors can use the classic cash discounting/compounding formula to analyse two or more investment opportunities with cash flows occurring over the same time period using a discount rate equivalent to their required rate of return. Investment opportunities offer various rates of return and various levels of risk. Any new opportunity has to be compared with the returns on another investment with equivalent risk. The PV is a function of the discount rate and the timing of cash flows. Different rates result in different PVs. Similarly for time periods. But PV cannot be used as a comparator for the relative desirability of different investments i.e. investment A is not necessarily superior to investment B simply because it has a higher PV.
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