The Time Value of Money1

For both accounting and finance, it is critical to understand the time value of money. This chapter begins with a review of compounding and discounting and then extends the discussion to explain the concept of net present value (NPV), why it is superior to other valuation methods (namely, the internal rate of return and payback) and reviews perpetuities (payments that continue forever) and their usefulness in valuation.

Discounting and Compounding

The time value of money is one of the most powerful concepts in finance. It is a concept that small children express when they say, “I want it now, not later, now!” Quite simply, the idea is that a dollar today (or anything, for that matter) is worth more than a dollar ...

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