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Dear Sir,
I have just come across this topic in F7. Could you please explain in more detail? Or give an example. Where could I read more about it?
Thanks.
Anna! If I have to pay $1.26 in 3 years’ time and the cost of capital for me is 8% the I should invest how much TODAY in order to have $1.26 available in 3 years’ time?
I need to discount the future payment to arrive at the equivalent TODAY figure so that I shall have $1.26 available in 3 years
So!
$1.26 / (1.08, 1.08, 1.08) = $1.00 today’s value of the future cash payment of $1.26 in 3 years where my cost of capital is 8%
This exercise is called discounting and the concept is known as discounted cash flows or dcf
Now, if I recognise $1 today for this obligation in 3 years, by the end of 12 months that obligation is 1 year closer so I will need to unroll the discount
$1 x 1.08 = $1.08 and the obligation will now be shown as $1.08
That added $0.08 represents the finance cost associated with unrolling the discount
Is this getting any clearer?
If so, fine
If not, try John’s lectures for F2 on this site
OK?
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