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Correction Constants for Present Values of Sub‐Annual Cash Flows *
Author(s) -
McMath H. Kent
Publication year - 1990
Publication title -
decision sciences
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 1.238
H-Index - 108
eISSN - 1540-5915
pISSN - 0011-7315
DOI - 10.1111/j.1540-5915.1990.tb01253.x
Subject(s) - cash flow , econometrics , constant (computer programming) , discounting , value (mathematics) , capital budgeting , simple (philosophy) , relevance (law) , economics , computer science , mathematics , statistics , finance , philosophy , epistemology , project appraisal , political science , law , programming language
When future cash flows are expected to occur at sub‐annual intervals, it is widely recognized that present value estimates are biased by the common assumption that each year's flows occur at year‐end. Although a “brute force” remedy for the end‐of‐year (EOY) bias is well known, the method does not appear to be generally used for financial decisions. The author suggests the possible reasons for continued tolerance of EOY bias are that the present method for eliminating the bias is too cumbersome or that the amount of bias is thought to be negligible. The paper also (a) examines the current remedy, indicating several features that hamper its use, (b) presents a correction constant approach that simplifies calculation of unbiased present values for streams of sub‐annual cash flows, (c) derives expressions for correction constants under two alternative assumptions about sub‐annual discounting, and (d) demonstrates use of the constants and the possible decision‐relevance of EOY bias by a simple capital budgeting example.