The accountant of Ronier, Inc., has prepared an analysis of a proposed capital project using discounted cash flow techniques. One manager has questioned the accuracy of the results because the discount factors employed in the analysis have assumed the cash inflows occurred at the end of the year when the cash inflows actually occurred uniformly throughout each year. The net present value calculated by the accountant:
A) will be in error and therefore not usable.
B) will be slightly overstated but usable.
C) will be slightly understated but usable.
D) will produce an error the direction of which is undeterminable.

Question

Quizplus · Accepted Answer

Assuming cash flows occur at the end of each year instead of uniformly throughout each year is a common simplification used in discounted cash flow analysis. This simplification slightly understates the net present value. Therefore, the net present value calculated by the accountant is still usable, but it may be slightly understated.

The Accountant of Ronier, Inc