Question:
Which of the following methods for calculating profitability does/do NOT consider the time value of money?
Which of the following methods for calculating profitability does/do NOT consider the time value of money?
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Check which formulas contain a (1+i)^t discount factor; the ones without it ignore the time value of money.
Updated On: Jul 17, 2026
- rate of return on investment
- discounted cash flow rate of return
- payback period
- net present worth
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The Correct Option is A, C
Solution and Explanation
Step 1: Classification of profitability evaluation methods.
In plant design and engineering economics, the standard methods used to judge project profitability are grouped into two categories based on whether they discount future cash flows back to a common point in time before comparing them, that is, whether they account for the time value of money.
Step 2: Methods that do NOT consider the time value of money.
Rate of return on investment (accounting or average rate of return) is computed as ROI = average annual net profit / original total investment. No discounting of future cash flows appears anywhere in this ratio; a rupee of profit earned in year 1 is weighted the same as one earned in year 10. This makes option (A) a method that ignores the time value of money.
Payback period is defined as Payback period = original investment / average annual cash inflow. Cash flows in different years are simply added at face value with no discount factor, so payback period, option (C), also does not consider the time value of money.
Step 3: Methods that DO consider the time value of money.
Discounted cash flow rate of return (DCFRR), option (B), is the discount rate i that makes the net present value of all cash flows equal zero. The presence of the discount factor means this method inherently accounts for the time value of money.
Net present worth (NPW), option (D), discounts every future cash flow back to the present before summing, which again explicitly uses discounting.
Step 4: Conclusion.
Only the two methods using undiscounted, face value cash flows, rate of return on investment and payback period, fail to account for the time value of money.\[ \boxed{\text{Rate of return on investment and payback period do NOT consider the time value of money.}} \]
In plant design and engineering economics, the standard methods used to judge project profitability are grouped into two categories based on whether they discount future cash flows back to a common point in time before comparing them, that is, whether they account for the time value of money.
Step 2: Methods that do NOT consider the time value of money.
Rate of return on investment (accounting or average rate of return) is computed as ROI = average annual net profit / original total investment. No discounting of future cash flows appears anywhere in this ratio; a rupee of profit earned in year 1 is weighted the same as one earned in year 10. This makes option (A) a method that ignores the time value of money.
Payback period is defined as Payback period = original investment / average annual cash inflow. Cash flows in different years are simply added at face value with no discount factor, so payback period, option (C), also does not consider the time value of money.
Step 3: Methods that DO consider the time value of money.
Discounted cash flow rate of return (DCFRR), option (B), is the discount rate i that makes the net present value of all cash flows equal zero. The presence of the discount factor means this method inherently accounts for the time value of money.
Net present worth (NPW), option (D), discounts every future cash flow back to the present before summing, which again explicitly uses discounting.
Step 4: Conclusion.
Only the two methods using undiscounted, face value cash flows, rate of return on investment and payback period, fail to account for the time value of money.\[ \boxed{\text{Rate of return on investment and payback period do NOT consider the time value of money.}} \]
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