Question

Why it’s so important for everyone to understand and grab the concept of compounding in the financial word? Same for Net Value and the significance of this indicator for decision-making?

Answer 1

The concept of compounding is extremely essential and importance to understand in finance since firstly it is a logical and practical concept. Secondly not considering the compounding effect will lead to incorrect calculations and thereby incorrect decisions. For example if a person is faced with faced with two investment options- 1 which offers simple interest and the other which offers compound interest both at the same rate and for the same period, ignoring the compounding factor main lead to incorrect decisions and finally financial losses.

Net value is also an important concept in finance since it provide the net value added by a particular decisions. Under this concept all relevant cash flows are to be considered and the time value of money is also taken into account. The net value is calculated as the difference between cash inflows and outflows and the project is accepted if the net value is positive.