Use Discounted Cash Flow Models to Make Capital Investment Decisions

If you have more than one investment opportunity but can only afford one, which one will you choose? You are presented with a chance to acquire new equipment that can improve your operating efficiency and help you to increase your sales, but is it worth the cost? After reading the material in this section, you will be able to calculate the value of an investment using discounted cash flows.

Your company, Rudolph Incorporated, has begun analyzing two potential future project alternatives that have passed the basic screening using the non–time value methods of determining the payback period and the accounting rate of return. Both proposed projects seem reasonable, but your company typically selects only one option to pursue. Which one should you choose? How will you decide? A discounted cash flow model can assist with this process. In this section, we will discuss two commonly used time value of money–based options: the net present value method (NPV) and the internal rate of return (IRR). Both of these methods are based on the discounted cash flow process.

Source: Openstax, https://openstax.org/books/principles-managerial-accounting/pages/11-4-use-discounted-cash-flow-models-to-make-capital-investment-decisions
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