Other things remaining equal, the present value of a future cash flow decreases if the investment time period increases. NPV (short for Net Present Value), as the name suggests is the net value of all your future cashflows (which could be positive or negative) For example, suppose there’s an investment opportunity where you need to pay 10,000 now, and you will be paid 1000 per year for the next 20 years. Other things remaining equal, the present value of a future cash flow increases if the investment time period increases. Which of the following is true about present value calculations? Assuming that both investments have equal risk and Eric’s investment time horizon is flexible, which of the following investment options will exhibit the lower price?Īn investment that matures in eleven years The opportunity cost (interest rate) of holding the security is 13.80%. NPV is similar to the PV function (present value). The security that earns an interest rate of 5.50%.Įric wants to invest in government securities that promise to pay $1,000 at maturity. The security that earns an interest rate of 8.25%. The above formula gives the NPV value of 15,017, which means that based on these cash flows and the given discount rate (also called the cost of capital). Which of the following investments that pay will $5,000 in 12 years will have a higher price today? A net present value analysis involves several variables and assumptions and evaluates the cash flows forecasted to be delivered by a project by discounting them back to the present using information that includes the time span of the project (t) and the firms weighted average cost of capital (i). Present value Expected Cash Flow ÷ (1+Discount Rate)Number of periods. Which of the following is true about finding the present value of cash flows?įinding the present value of cash flows tells you what a cash flow will be worth in future years at a specified rate of return.įinding the present value of cash flows tells you how much you need to invest today so that it grows to a given future amount at a specified rate of return. Finding a present value is the reverse of finding a future value.
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