Capital budget process

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  • #235562
    Amir Badawy
    Participant

    Hi 

    Please can you help me for understand points 2 and 3 on the paragraph ” when do cash flows take place?”

    As per attached

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  • #235739
    Lynn Roden
    HOCK international

    Hello Amir Badawy,

    When time value of money concepts are being used, for example as in the calculation of NPV which uses present value, each cash flow must be assumed to be received at a single point in time during a year. If instead we were to assume that it was received equally over the period of each year, the interest rate at which the cash flow is discounted could not be applied to it. If you are not familiar with time value of money concepts, please see Appendix A in your CMA Part 2, Vol. 2 textbook.

    On the other hand, time value of money concepts are not used in calculating the payback period. Instead, the amount of time required for an investment to be recouped includes a fraction of a year, such as 3.5 years. Because it uses a fraction of a year in the payback period, it is necessary to assume that the cash flows are received evenly over the course of each year.

    Lynn

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