7. Capital Budgeting and Discounted Cash Flow Analysis

Discounted cash flow analysis is probably the most important financial tool that you will encounter. Fortunately, present values are easy to understand and easy to calculate. If you had the opportunity to choose between receiving $1,000 a year from today or receiving $1,000 today, which would you prefer? Clearly you would prefer to receive the cash today. If you received the money today, you could invest it and earn a return during the upcoming year. If you could invest at 5%, at the end of the year you would have $1,050 (your original $1,000 plus $50 in interest). So if 5% is the correct interest rate, a choice between $1,000 a year from now and $1,000 today is equivalent to a choice between ...

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