Final answer:
The correct answer to whether you must compound a cash flow to calculate its present value is b. False. The present value is calculated by discounting the future value of cash flows, which accounts for the time value of money.
Step-by-step explanation:
To calculate a cash flow's present value (PV), you must discount it, not compound it. Therefore, the correct answer to the question is b. False.
The present value is calculated by adjusting the future value of cash flows for the time value of money. The formula to find the present value from the future value using the regular compound growth formula is PV = FV / (1 + i)^n, where PV is the present value, FV is the future value, i is the interest rate, and n is the number of periods. To determine the compound interest, you calculate the difference between the future value and the present value of the principal.
In real-world calculations, factors such as market interest rates and the risk of the borrower not repaying the loan can influence the value. The price of a bond, for instance, is the present value of a stream of expected future payments. When you add up all the present values of future cash flows at a given interest rate, you obtain the total present value of those cash flows. This illustrates how the present value accounts for the time value of money and the cost of borrowing.