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Horngren'S Financial And Managerial Accounting
Found in: Page 1464

Short Answer

Why are net present value and internal rate of return considered discounted cash flow methods?

NPV and IRR are called the discounted cash flow method as they are based on the time value of money and discount the future cash flow to the present value.

See the step by step solution

Step by Step Solution

Step1: Meaning of Discounted Cash Flow

Discounted cash flow is based on the time value of money. It is the amount that represents the present value of a future amount.

Time value of money states that the value of money today would not be equal to the value of money tomorrow due to the factor of interest payment.

Thus the discounted cash flow equates the future cash flow to the present value by discounting the interest factor.

Step 2: Net present value and internal rate of return considered as discounted cash flow methods

streams and present cash outflow. Under this method,future cash flows are discounted to the present value.

The internal rate of return is the rate at which the present value of all future cash flows equates with the present value of cash outflows.

Conclusion:-

Thus as discussed, these two methods use the time value of money concepts and discount the future cash flow to the present value by considering the interest rate factor; these methods are called the discounted cash flow method.

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