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Time Value of money, cost of capital, NPV

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1. Discuss how the concept of "the time value of money" is critical when making capital investment decisions.
2. Discuss "cost of capital" and its relevance when making capital investment decisions.
3. Suppose that a firm must choose between two mutually exclusive projects, both of which have negative NPV. Explain how a firm can legitimately choose between two such projects

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Solution Summary

Your tutorial is 398 words and gives examples to illustrate how the time value of money and cost of capital play out in capital decision. The discussion gives three potential ways to decide between two projects with negative NPVs.

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1. Discuss how the concept of "the time value of money" is critical when making capital investment decisions.
The time value of money means that money today is worth more than money later because it can be invested so that it gets bigger over time. Capital investment decisions compare the value today with the potential value in later years. If you don't discount future dollars, you will think you are increasing your wealth, but the cost of capital may be eroding your wealth faster than the project is increasing your wealth. For example, if you invest $100 today and it will give you $120 in year 5, you would think you are getting a 20% return without considering the time value of money. However, if ...

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Carol Sargent, PhD
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  • BSc, University of Virginia
  • MSc, University of Virginia
  • PhD, Georgia State University
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