Open AccessInvestment Appraisal and the Choice between Continuous and Discrete Cash Flow Discounting
Author(s) -
Luiz Ricardo Cavalcante,
Carlos Henrique Rocha
Publication year - 2018
Publication title -
exacta
Language(s) - English
Resource type - Journals
eISSN - 1983-9308
pISSN - 1678-5428
DOI - 10.5585/exactaep.v16n4.8143
Subject(s) - cash flow , operating cash flow , net present value , terminal value , capital budgeting , cash flow forecasting , investment (military) , cash flow statement , economics , cash management , discounting , revenue , return on investment , cash and cash equivalents , microeconomics , econometrics , finance , production (economics) , project appraisal , politics , political science , law
The vast majority of corporate finance textbooks presents the problem of investment decisions considering discrete cash flows at the end of each period. However, on several occasions, this assumption does not fit the facts, as in the case of the revenues of large retailers, which tend to be generated almost continuously, instead of at the end of each year. In this paper, we compare the net present value of a typical investment considering both a discrete distribution of expected cash flows and a continuous one. We show that the differences observed depend upon the behavior of the function that describes the cash flows and upon the capital cost used to discount the values. Differences tend to be higher if higher capital costs are used. As a result, riskier projects are more sensitive to the right choice of the cash flow distribution to be used in its appraisal and no method can be considered, a priori, better than the other, as operational, fiscal and accounting aspects may make continuous or discrete cash flows more appropriate to describe practical realities. Thus, the article contributes to better supporting investment decisions and to enriching teaching material addressing the subject of investment decisions.