The author of the post makes a good point that an amount of money is worth more the sooner it is received. At first glance, it seems paradoxical because a bundle of money comprised of ten banknotes with the denomination of US $100 equals the US $1000 anywhere and at any time (if the fluctuation rates and inflation are ignored). However, the given paradox has a very simple explanation: when a person has a particular sum now, he or she can invest it, i.e., make it work for his/her own benefit and get more profit by the end of a particular period. For this reason, “any amount of money is worth more the sooner it is received” since “money can earn interest” (Time Value of Money, n.d., para. 1). It means that the aspect of time must be taken into account when planning, analyzing, and evaluating future cash flows; evaluating the effectiveness of investments; and in all other cases when it is necessary to compare monetary amounts related to different time periods.
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In financial accounting, the discounting of cash flows is used to ensure the comparability of financial reporting data of either different companies or for different reporting periods. The discount rate usually includes a preference for current consumption, estimated inflation, and probable uncertainty in cash flows (Damodaran, n.d.). Overall, discounting operations can be reduced to the following formula: PV = FV / (1 + i)n where “i” is the discount rate and “n” is the time (number of periods) (Gollier, n.d.). This formula implies that when discounting future cash flows, the financier simply reduces them by the amount of the opportunity costs associated with these flows. In other words, he or she subtracts a particular sum of expected costs from the amount of income.
Damodaran, A. (n.d.). The Time Value of Money. Web.
Gollier, C. (n.d.). Time horizon and the discount rate. Web.
Time Value of Money – TVM. (n.d.). Web.