The Concepts of Discounting and Time Value of Money in Islamic Capital Budgeting Framework: A Theoretical Study

Abstract

The concept of discounting is a most important issue in the world of economics and finance from both conventional and Islamic perspective,because it relates to capital and interest. Islamic finance cannot depend on the conventional techniques of capital budgeting because of interest. Conventional capital budgeting techniques involve time value of money and discounting the future cash flows in this respect which is strictly prohibited in Islam. There are two aspects of discounting; evaluation tool and consideration. A few scholars have discussed the time value of money and discounting in different aspects but all studies ignored the role of discounting as an evaluation tool. They also did not distinguish the time value of money from the concept time value of commodity. The purpose of this study is to answer the question whether discounting as an evaluation tool is permissible in Islamic perspective or not? The study will also differentiate the time value of money from time value of commodity. The study also clarifies that there is no objection in taking time value of money just for sake of capital budgeting and what is prohibited is time value of money taken as consideration.

Keywords: Capital budgeting in Islam, Time value of Money, Discounting in Islam, time preference theory, Functions of Money

JEL Classification: B20