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The following information relates to a two-year project:
Initial investment – $1 million
Cash inflow year 1 – $750,000
Cash inflow year 2 – $500,000
Cost of capital year 1 – 10%
Cost of capital year 2 – 15%What is the net present value of the project?(to the nearest $500)
A. ($12000)
B. ($55000)
C. $77000
D. $116500Discount the year 1 cash flow by 1 year at 10%
Discount the year 2 cash flow by 1 year at 15% and then by 1 year at 10%
Then you will have it 🙂
Hi sir.. sorry but I still don’t get it. Could you please explain in details.
Thank youI assume that you have watched my lecture on investment appraisal?
If so, then you will know that in order to discount the year 1 flow of 750,000, you multiply by the one year discount factor at 10%.
In order to discount the year 2 flow of 500,000, you would usually multiply by the 2 year discount factor at the cost of capital. However, because here the cost of capital changes, you discount for 1 year at 10% (i.e. multiply by the one year discount factor at 10%) and then by another year at 15% (so multiply the figure you now have by the 1 year discount factor at 15%).
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