Computing Present Values: Capital Budgeting Done Correctly
15 Pages Posted: 25 Jan 2014
Date Written: January 23, 2014
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: Suggested Citation