Time-Pattern of Benefits (Profits)



It can be seen from Table 1.1 that the total profits associated with the alternatives, A and B, are identical. If the profit maximization is the decision criterion, both the alternatives would be ranked equally. But the returns from both the alternatives differ in one important respect, while alternative A provides higher returns in earlier years, the returns from alternative B are larger in later years. As a result, the two hematite courses of action are not strictly identical. This is primarily because a basic dictum of financial planning, is the earlier the better as benefits received sooner are valuable than benefits received later. The reason for the superiority of benefits now over benefits later lies in the fact that the former can be reinvested to earn a return. This is referred to as time value of money. The profit maximization criterion does not consider the distinction between returns received in different time periods and treats all benefits irrespective of the timing, as equally valuable. This is not true in actual practice as benefits in early years should be valued more highly than equivalent benefits in later years, The assumption of equal value is inconsistent with the real world situation.

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