Evaluating investments: Screening, Ranking, and Discounting
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I have read through my textbook and searched the web. I feel like this is a trick question. Which one is a true statement and why? Why the others are false.
Which of the following statements is correct?
a. Screening is the process of finding the best among available acceptable alternatives.
b. Ranking is the process of determining whether an investment meets a minimum standard of financial acceptability.
c. For the comparison of cash flows to be accurate, all amounts should be stated at their value at the point in time when the cash flow occurs.
d. Cash received sooner is worth more than cash received later.
e. Generally speaking, managers use relatively low discount rates when evaluating investments that involve a high degree of risk.
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Solution Summary
Solution discusses the time value of money, discounted cash flow, ranking, and screening.
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The correct answer is d.
Time Value of money: The discounting of future cash flows to arrive at the intrinsic value of an asset has a fundamental place in finance theory. Investing can be defined as the outlay of money today with the expectation of collecting more money at some point in the future. Therefore if one assumes that an individual would collect more money in the future than was paid initially, this investment would be valued by summing all the money to be collected in the future. It is more beneficial to collect money sooner rather than later and this is taken into consideration in any cash flow model. Money is worth more than the same amount at some time in the future. This is referred to as the "time value" of money.
The time value of money affects the valuation of an asset because we assign different weights to each cash flow depending on when it is received. Said differently, we "discount" the future ...
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