Why has the time value of money been ignored while summing profits for the Dosa example?



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The yearly profits(@T=1,2,3) cannot be summed up to Rs. 4,50,000 as it basically ignores the fact that a dollar worth today is not worth a dollar tomorrow.

4 Answer(s)


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Good observation!
The TVM is used only when you are calculating a ROI on your investment or want to calculate the value of the company today.
When you just want to know about the future operational performance of a company you dont use TVM and use the numbers as is.

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This is done because for valuation purposes you want to know what is the value of the company today and hence use TVM to discount.
While analysing operations of the company you want to understand what will be the company worth 3 years from now.

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Thanks Binny for your quick response!
I believe and correct me if I am wrong that we use Discount cash flows(profits) to arrive at NPV of project. But I could never understand how we determine the Cost of capital(r). We can calculate IRR(or ROI) but how do we determine the cost of capital in valuing a project?

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Sorry about the delay in replying. The most common method to determine Cost of Capital is WACC - Weighted Average Cost of Capital (we have an entire module in our advanced course that focuses on this topic).

Very basically put cost of capital is the sum of your cost of equity + cost of debt. The Cost of debt is nothing but the interest rate you have to pay on debt.

Cost of equity is the return that an investor needs to buy shares in your company. This is typically calculates using the CAPM or the Capital Asset Pricing Model.