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An organization with a cost of capital of 14% plans to invest in a project costing $500,000. The project will yield nothing in Year 1, but from Year 2 would yield cash inflows of $100,000p.a. in perpetuity. Access its feasibility.
This is an example of Bpp textbook. And the answer is:
year CF discount factor present value
0 (500,000) 1 (500,000)
1 0 0.877 0
2-? 100,000 1/0.14*0.877 626,429And I wonder why it is 1/0.14*0.877 instead of 1/0.14-0.877 here because another similar example presented later offer the PV factor=(factor 1-?)-(factor yr1), and I think the later formula makes more sense.
Could you please tell me whether discount factor and the PV factor are the same thing?
Whether I am right to calculate in 1/0.14 minus 0.877?I’ve calculated this and it seems to be only rounding errors?
You can calculate the factor either way.
For 2 to infinity, you can either take 1 to infinity and subtract the factor for 1 year (which is perhaps the most obvious way.
Alternatively, you can take 1 to infinity, but then multiply by the 1 year factor because the perpetuity starts one year late (it starts at time 2 instead of time 1).
Both ways give the same answer (apart from rounding differences, because the tables only go to three decimal places). Rounding differences are irrelevant in the exam – they are marking your workings.
The present value factor is the discount factor!
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