Present value method cs financial management notes
Present value method: This concept is useful as a decision criterion because it reveals the fact that the value of money is constantly declining as a rupee received today is more in value than the rupee at the end of a year.
Besides, if the rupee is invested today it will fetch a return on investment and accumulate to Re. 1 (1+i) at the end of ‘n’ period. Hence a rupee received at the end of ‘n’ period is worth 1/(1+i)n now. Investment decisions require comparison of present value with the cost of assets, and if the present value exceeds the cost, the investment is rendered acceptable. Another off-shoot of this criterion is net present value method which is closely related to cost-benefit ratio. It takes into account all income and its timing with appropriate weights. Here difference of present value of benefits and costs is considered as against the ratio in cost-benefit analysis. This criterion is useful for acceptance of projects showing positive net present value at the company’s cost of capital rate. It can be used for choosing between mutually exclusive projects by considering whether incremental investment yields a positive net present value.
In short this means hard cash in your hand has more importance than future aspect money. Liquidation of hand cash is much importance because you can take quick decision by it.