I have done NPV calculations in the past in Excel and used the following formula; =NPV(Rate;CF1;CF2;CF3;CF4;CF5)-investment

I get to the NPV of 6’067

Am I making a mistake in my calculation or is this a “rounding difference”.
I know we won’t be able to use a computer but it will help to check my answers.

I have understood the process of discounting as in how it is done, but I am having trouble understanding why we do discounting. In your lecture notes, it is written that cash flows are discounted to account for the fact that money will be tied up on the project for a period of years and this will therefore either result in interest being paid or lost, but why is interest being paid or lost on tied up money a problem? why do we need to remove it?
In the example 1, the cash inflow from year 1 is $20000 but after discounting at 10% it is $18180 so that means $1820 (20000-18180) is the interest, but how does this $1820 get included in the $20000 cash inflow, i mean interest either gets paid or lost, right? we’re assuming that each year more and more interest gets included in cash inflow but how does it get included?
Also, thank you for the great lecture videos

With interest at 10%, you would need to invest $18,180 to get back $20,000 in 1 years time.

If a project cost 15,000 now and gave 20,000 in 1 years time then it would be worth investing in the project (because 15,000 is less that 18,180). If, on the other hand, a project cost 19,000 now and gave 20,000 in 1 years time, then it would not be worth investing because 19,000 is more than 18,180.

It will help you to watch the Paper F2 lectures on interest and on investment appraisal, because basic discounting (and the reason for it) is revision of Paper F2.

Theodoor says

I have done NPV calculations in the past in Excel and used the following formula; =NPV(Rate;CF1;CF2;CF3;CF4;CF5)-investment

I get to the NPV of 6’067

Am I making a mistake in my calculation or is this a “rounding difference”.

I know we won’t be able to use a computer but it will help to check my answers.

Thank you for your reply.

John Moffat says

You have made a mistake. There are only 4 years of inflows not 5. The scrap proceeds are in 4 years time.

Theodoor says

Thank you sir,

I see, I think I am not supposed to discount the scrap value of 10K.

Thank you for your reply.

John Moffat says

Yes of course you should discount it, but it is in 4 years time – not 5 years time as you have written it.

peachy says

Hello sir,

I have understood the process of discounting as in how it is done, but I am having trouble understanding why we do discounting. In your lecture notes, it is written that cash flows are discounted to account for the fact that money will be tied up on the project for a period of years and this will therefore either result in interest being paid or lost, but why is interest being paid or lost on tied up money a problem? why do we need to remove it?

In the example 1, the cash inflow from year 1 is $20000 but after discounting at 10% it is $18180 so that means $1820 (20000-18180) is the interest, but how does this $1820 get included in the $20000 cash inflow, i mean interest either gets paid or lost, right? we’re assuming that each year more and more interest gets included in cash inflow but how does it get included?

Also, thank you for the great lecture videos

John Moffat says

Discounting is effectively removing the interest.

With interest at 10%, you would need to invest $18,180 to get back $20,000 in 1 years time.

If a project cost 15,000 now and gave 20,000 in 1 years time then it would be worth investing in the project (because 15,000 is less that 18,180). If, on the other hand, a project cost 19,000 now and gave 20,000 in 1 years time, then it would not be worth investing because 19,000 is more than 18,180.

It will help you to watch the Paper F2 lectures on interest and on investment appraisal, because basic discounting (and the reason for it) is revision of Paper F2.

peachy says

I think I have understood it now. Thank you very much, sir. Your explanations are always brilliant 🙂

John Moffat says

You are welcome 🙂