How do financial managers evaluate capital budgeting proposals?
Time value of money recognizes that sooner the cash is received, the sooner it can be reinvested to earn more money.
Financial managers take time value of money into account by computing the present values of all cash flows the proposal will generate.
Present value of a sum of money received in the future is the amount of money today that will become that future amount if it is invested at a specified rate of interest. Net present value (NPV) is sum of present values of all the estimated future cash flows, minus the initial cost of the investment.