Final answer:
Discounting is used to account for cash flows occurring throughout the year instead of at a single point in time. By applying a discount rate, we can determine the present value of the cash flows and calculate the net present value (NPV).
Step-by-step explanation:
When considering cash flow occurring throughout the year instead of at a single point in time at the end of the year, we use a method called discounting. This takes into account the time value of money, which means that money received earlier is worth more than money received later due to the ability to invest and earn returns.
Discounting involves determining the present value of cash flows by applying a discount rate. The discount rate represents the opportunity cost of investing the money elsewhere. By discounting each cash flow, we can calculate the net present value (NPV) which takes into account the timing of the cash flows.
For example, if we have cash flows of $1,000 each month for a year, and the discount rate is 5%, we would discount each cash flow based on its timing and sum them up to calculate the NPV.