Capital budgeting techniques are used to evaluate investment projects by analyzing potential costs and benefits. One key consideration in capital budgeting is the time value of money (TVM), which states that a dollar received today is worth more than a dollar received in the future due to its earning potential.
Why Option C (Discounted cash flow) is Correct:
Discounted Cash Flow (DCF) explicitly incorporates the time value of money by discounting future cash flows to their present value.
Methods such as Net Present Value (NPV) and Internal Rate of Return (IRR) fall under DCF analysis, making them highly reliable for long-term capital budgeting decisions.
Why Other Options Are Incorrect:
Option A (Annual rate of return):
Incorrect because the annual rate of return (ARR) is based on accounting profits and does not consider the time value of money.
Option B (Incremental analysis):
Incorrect because incremental analysis is a decision-making tool that compares alternative costs and revenues but does not discount future cash flows.
Option D (Cash payback):
Incorrect because the payback period method only measures the time needed to recover an investment and ignores the time value of money.
IIA GTAG – "Auditing Capital Budgeting Decisions": Discusses the importance of time value of money in investment decisions.
COSO ERM Framework – "Risk Considerations in Financial Planning": Recommends using DCF methods for capital investment decisions.
IFRS & GAAP Financial Reporting Standards: Advocate for using DCF techniques for asset valuation and investment analysis.
IIA References:
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