A rational person is not indifferent between having a pound in his/her possession today or receiving a pound in the future. In general a sum of money which today may be invested in a project, or as capital in a firm, should earn a higher return on investment during the life of the project than that which it can receive if kept on deposit in a bank or government bonds, for instance. These investment possibilities, saving in a bank or in bonds are meant to be risk free.
However, investing in a company or a project, such as a building or infrastructure, carries risk, which needs to be taking into account when appraising an investment opportunity.
The procedure for accounting for the delay in receiving funds until sometime in the future is to discount, or penalise, future cash flows of revenue and costs thus of profits or losses. The longer we must wait to receive them, the more heavily we have to discount them. This discounting procedure converts future cash flows that occur during several years into a single current or “today’s” value of return on investment.
It allows the comparison between alternative investments, which can then be compared because of the comparison would be between single
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