Discounted cash flow time value of money

Discounted cash flow (time value of money) 

The money earned in any year can be put to work (reinvested) as soon as it is available and start to earn a return. So money earned in the early years of the project is more valuable than that earned in later years. This time value of money can be allowed for by using a variation of the familiar compound interest formula. The net cash flow in each year of the project is brought to its present worth at the start of the project by discounting it at some chosen compound interest rate. 

Net present worth (NPW) Estimated net cash flow in year n (NFW) 

The discount rate is chosen to reflect the earning power of money. It would be roughly equivalent to the current interest rate that the money could earn if invested. 

The total NPW will be less than the total NFW, and reflects the time value of money and the pattern of earnings over the life of the project see Example 6.6. 

Most proprietary spreadsheets have procedures for calculating the cumulative NPW from a listing of the yearly net annual revenue (profit). Spreadsheets are useful tools for economic analysis and project evaluation. 

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