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Homework answers / question archive / A firm is valuing a project that is expected to produce the following cash flows over thenext eight years:Year Cash Flow15,00026,50037,00048,00058,00068,00078,00089,500a
A firm is valuing a project that is expected to produce the following cash flows over thenext eight years:Year Cash Flow15,00026,50037,00048,00058,00068,00078,00089,500a. What does the term discounting mean in finance? What is a discount rate?b. What is the present value of these cash flows at a discount rate of 8%?c. What is the present value of these cash flows at a discount rate of 12%? What is therelationship between present values and interest rates?
a) The process of calculating the present value of future cash flow receipts is called discounting. It takes into account the time value of money. A sum of money is worth more today than it is worth tomorrow. The process of discounting involves the use of a discount factor based on time and interest rate.
The interest rate used to determine the present value of future cash flows in a discounted cash flow (DCF) analysis is called Discount Rate. This helps determine if the future cash flows from a project or investment will be worth more than the capital outlay needed to fund the project or investment in the present.
b&c)
d) As we know that,
Present Value = Future Value / (1 + Interest Rate)^Number of Years
Higher the interest rate, lower the present value while Lower the interest rate, higher the present value. So, we can say that Interest rate and present value are inversely related.
