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Hey John, Hope you are doing well.
I have a query. In this question, the Initial invesment of expansion is given as $15m, denoted by Pe in the BSOP model formula. The present value of returns, which I donate by Pa, its amount however is calcualted by multiplying the $15m with the 3 year discount rate of 0.712. I understand from where we get the 15m amount that is to be multiplied with the discount rate, but I don’t understand why we are discounting it.
Can you please explain this along with any indicators in the question that I must look for and realise quickly that I must discount the value. Because the values have not been discounted in any of the previous BSOP questions which i have done apart from this one. This is the first.
Thank youThe wording of the question is slightly confusing (but is correct).
When it says that the expected NPV of the expansion is estimated to be $0 it is meaning that the NPV in 3 years time is estimated to be $0. So $15M is the PV in 3 years time of the future inflows. For Pa we need the PV ‘now’ and so we need to discount it for 3 years.
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