Chapter 12, Problem 1QC

To determine

To identify: The correct methods of analyzing capital investments factors in the time value of money among given options.

Answer to Problem 1QC

Option b. The internal rate of return method involves time value of money in analyzing capital investment factors.

Explanation of Solution

a.

Accounting rate of return is calculated on the basis of operating profit earned on the investments. This method does not require time value of money. This is an incorrect option.

b.

Internal rate of return uses discounted cash inflows and out flows for valuation of money in the projects. So, it does involve time value of money. Hence, this is the correct option.

Use of time value of money gives an appropriate idea of future and present money as it includes interest rate factor in determining the value of money. Discounting or compounding of money requires time value of money concept.

c.

Payback period involves operating cash inflow to find the value of it. This method does not involve the time value of money. It is based on the value of money as it is. Hence, it is an incorrect option.

d.

All of the above methods factor in the time value of money. As correct option is c so, this option is incorrect.