Question

The frequency of compounding associated with the rate used to discount cash flow is independent from the # of years until the cash flow is received

1. True
2. False

Answer 1

a. True. Correct. The number of years of cash flow does not matter in the rate of discount. The frequency of compounding periods in a year matters. So, the discount rate is independent whether the cash flows come for 5 years or till infinity. But if the discount rate is 6% compounded semi annually, then yearly effective rate of interest will be (1+nominal rate/number of periods)^(number of periods) - 1

= (1+0.06/2)^2 - 1 = 6.09%.

Similarly if the number of compounding periods in a year increases, then through the above formula the effective rate can be found. Number of years of cash flow that is received is not related here.

Thus, the answer is true and not false.

Comment in case of any queries.