3.8 Investment Appraisal HL
CONGRATS!
You just won $1 Million
on
America's Got Talent
for your superior abilities in
POWER JUGGLING ON UNICYCLES
(Your Grandma must be so proud)
One little problem. That whole $1 million prize is complete BS. Look at the fine print - the money is paid over the course of the next 40 years! On average that is $25000/ year. Is this the same as getting $1 million today? Nope! Will it get you the same purchasing power as $1 million today? Not a chance!!
What is this prize REALLY worth?
POLL TIME!
1. Make a table the following rows: Year, Cash Flow, Discount Factor and Present Value.
2. Fill in years and cash flow. To find discount factor use the discount factor table and use the corresponding year with the rate given. Note that discount factor for year 0 is 1.
3. Calculate present value for each year by multiplying cash flow * discount factor.
4. Sum up all the years present values to get your NPV. You're done!
NPV (Net Present Value) takes into account discounted cash flow and finds value of an investments in today's money. An example of this is if you need to get a loan at 5% interest, what do you really make? Another example is using the expected inflation rate for your discount rate. Some investments in Vietnam may get you a 10% return over a year but when inflation is 18%, you actually lost money based on today's value.
