– It considers time value of money.

– The major concept of this is that money available at the present time is worth more than the same amount in the future due to its potential earning capacity.

– This core principle of finance holds that, provided money can earn interest, any amount of money is worth more the sooner it is received.

            It includes:

A) B/C ratio:

– It is defined as the ratio of discounted benefit stream to discounted cost stream.

– OR it is the ratio of present worth of incremental benefit stream (cash inflows) to present worth of incremental cost stream (cash outflows) due to enterprise.

– When it is expressed in percentage it is called profitability coefficient.

Note : The  absolute  value  of  BCR  will  vary  depending  on  the interest  rate  chosen.  The  higher  the  interest  rate,  the  smaller  the  resultant  benefit-cost  ratio.

Decision Criteria:

I) If the B/C ratio is greater than 1 project is accepted.

ii) If the B/C ratio is less than1 project is rejected.

iii) If the B/C ratio is one than decision is indifference.

Benefits

– NPV and B/C ratio are similar because if NPV is +ve then B/C ratio is greater than 1.

– This method is simple and easy to calculate.

– Used in ranking the mutually exclusive project but cannot be used in ranking non-mutually exclusive projects.

Demerit

– This method discriminate with the projects with low B/C ratio but have large wealth generating capacity than the alternatives with higher B/C ratio but low income generating capacity.

B) Net present worth:

– The present worth of the benefits less the present worth of the costs of a project called NPV/NPW.

– It is present value of incremental net benefit.

–  It is the discounted profit in absolute form.

Decision criteria:

a) NPV +ve = Accepted

b) NPV -Ve = Rejected

c) NPV 0 = Indifferent