How is the present value of future cash flows calculated?

The present value of future cash flows is calculated by discounting those cash flows at an appropriate rate. This process is essential in financial analysis, allowing investors and analysts to determine how much future cash flows are worth in today's terms. The discount rate reflects the time value of money, which acknowledges that a dollar today is worth more than a dollar in the future due to factors like the potential for investment returns.

By discounting future cash flows, one can assess their current worth, factoring in risks and the opportunity cost of not investing the money elsewhere. The formula involves taking each future cash flow and dividing it by (1 + discount rate) raised to the power of the number of periods until the cash flow is received. This approach provides a more accurate financial perspective and aids in decision-making regarding investments and pricing.

The other options do not represent the correct method for calculating present value. For instance, merely adding future cash flows ignores the time value of money, and multiplying by the discount rate does not calculate present value but rather alters the cash flows without a proper adjustment for timing. Similarly, adjusting cash flows for inflation rates addresses price level changes but does not provide a definitive present value calculation.