Computing Present Values: Capital Budgeting Done Correctly

15 Pages Posted: 25 Jan 2014

See all articles by Robert A. Jarrow

Robert A. Jarrow

Cornell University - Samuel Curtis Johnson Graduate School of Management

Date Written: January 23, 2014

Abstract

This paper shows that the standard textbook formula for computing the present value of a future random cash flow - the discounted expected value - is formally incorrect and can generate significant errors when used to compute present values. The correct present value method is provided as well as a simple adjustment to the textbook formula which can be used to obtain an approximation to the correct value.

Keywords: present value, no arbitrage, capital budgeting

JEL Classification: G31, G12

Suggested Citation

Jarrow, Robert A., Computing Present Values: Capital Budgeting Done Correctly (January 23, 2014). Available at SSRN: https://ssrn.com/abstract=2383896 or http://dx.doi.org/10.2139/ssrn.2383896

Robert A. Jarrow (Contact Author)

Cornell University - Samuel Curtis Johnson Graduate School of Management ( email )

Department of Finance
Ithaca, NY 14853
United States
607-255-4729 (Phone)
607-254-4590 (Fax)

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