Why are NPV and IRR considered discounted cash flow methods?
They incorporate compound interest (by assuming that future cash flows will be reinvested when received) & make comparisons by converting all cash flows to the same point in time- namely present value.
NPV and IRR are considered discounted cash flow (DCF) methods because they take into account the time value of money. Time value of money refers to the concept that a dollar received today is worth more than a dollar received in the future due to the potential for earning interest or other returns on that dollar.
Both NPV and IRR use the concept of discounting to calculate the present value of future cash flows. NPV calculates the present value of all cash inflows and outflows of an investment at a specified discount rate, while IRR calculates the discount rate that makes the present value of all cash inflows equal to the initial investment.
DCF methods like NPV and IRR are useful for analyzing investment opportunities, as they provide a more accurate picture of the profitability of an investment by considering the time value of money.
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