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Hi Mr John…I’m little confused…
Interest rate p.a which banks offer us and interest of changing value in money are different things right?
For example If I put 10000£ in a bank with interest of 5% p.a….I’ll get extra 500£ in a year…Now if I want to know NPV I need to know the interest of changing value of money which is different from 5%….
What do you think of it? Thank you…I don’t know what you mean by “interest of changing value of money”.
The only reason for discounting is to account for the interest cost of borrowing money. Discounting is not done to account for inflation (even though – as you will find out in Paper F5 – higher inflation is likely to mean higher interest rates).
Hi Mr. John
I was having a problem in this question.
Able Ltd is considering a new project for which the following information is available :-
Initial cost= 300,000
Expected life is 5 years
Estimated scrap value= 20,000
Additional revenue from the project per year= 120,000
Incremental cost of the project is 30,000 per year
cost of capital is 10%Calculate NPV and ARR
For NPV:
There is an annuity of 90,000 (120,000 – 30,000) a year for 5 years, following by one inflow of 20,000 in 5 years time.
You need to discount the flows at 10% and then subtract the initial 300,000 to get the NPV.For ARR:
The net cash each year is 90,000 (120,000 – 30,000).
The depreciation each year is 56,000 ((300,000 – 20,000)/5))
So the profit per year = 34,000The average investment = 160,000 ((300,000 + 20,000)/2)
So the ARR = 34,000/160,000 = 21.25%The free lectures will help you on these.
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