Question

Why is present value calculated on cash flow and not on income? Answer of few sentences...

Why is present value calculated on cash flow and not on income?

Answer of few sentences would be sufficient.

Homework Answers

Answer #1

Solution:

In capital budgeting or investment appraisals, present value is calculated on cash flows and same is compared with initial investment to know that investment provides desired rate of return or not. The present value is calculated on cash flows because we compare the initial cash investment with present value of future cash flows. If we compare, present value of net income with initial investment, this will not be a peer to peer comparison. Further net income includes various non cash items like depreciation amortization etc.

In view of the above, present value calculated on cash flow and not on income.

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