- March 16, 2021 at 12:25 pm #614516maximus07Participant
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What is meant by these two different lines:
“The discount rate is the rate of return that will be sufficient to cover the cost of the organisation’s capital.”
“In theory, the value of the organisation should increase by the amount of the NPV if the investment goes ahead.”
Please explain.March 16, 2021 at 5:51 pm #614551Ken GarrettKeymaster
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An organisation’s cost of capital (CC) is a measure of the of interest and dividends the organisation has to pay investors. It’s like an interest rate. If that rate is 10% then any money raised by the company and invested has to earn at least 10% if the company is going to be able to adequately reward investors. The IRR is then 10%, a breakeven rate comparing earnings and payments to investors.
NPV is the present value of inflows less outflows discounted to the present. An NPV of, say, $10,000, is exactly equivalent to being given $10,000 now. A project yielding an NPV of $10,000 effectively makes the company $10,000 richer so its value should rise by that amount too.
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