Which process accounts for the cost of inflation and the time value of money?

The process that accounts for the cost of inflation and the time value of money is discounting. Discounting involves calculating the present value of future cash flows by applying a discount rate, which reflects the opportunity cost of investing capital elsewhere. This method recognizes that money available today is worth more than the same amount in the future due to its potential earning capacity, a principle known as the time value of money.

In addition, discounting takes inflation into account by adjusting future cash flows to reflect the decreasing purchasing power of money over time. By bringing these future cash flows back to their present value, it allows appraisers and investors to make informed decisions based on realistic expectations of value.

Other methods, such as direct capitalization or the sales comparison approach, do not specifically incorporate the time value of money within their frameworks in the same way discounting does. Direct capitalization focuses on converting income into value using a capitalization rate, while the sales comparison approach evaluates property values based on comparable sales data, both of which are essential but do not directly address inflation and the time value of money. Annuity capitalization relates specifically to valuing a series of cash flows over time, but it does not encompass the broader principles of discounting future cash flows.