Question

Remember that the discount rate is the interest rate that we use to find the present...

Remember that the discount rate is the interest rate that we use to find the present value of a cash flow or a lump sum. If you have $10,000 in 10 years, what would be the value of that $10,000 today. We would need to calculate the present value using 10 years as the number of periods (n), a discount rate (r) that we would need to determine, and we know the future value (fv) is $10,000. What if we are to receive $100 per month over the next 5 years. We would need to find an appropriate rate to use to discount the value of the cash flow ($100 per month for 5 years) to determine the value of that cash flow in today's dollars.

This is a good topic. It's important because it helps us determine if we should move forward with a project or an expansion. It can be used to help us determine if we should buy a business or help us determine the asking price of our business if we decide to sell our business. It's wonderful to know that our business brings us $100,000 per year in net profits, but how do we use this piece of information to determine the value of our business? Perhaps we would discount $100,000 each year for 5 years using a discount rate that we would need to determine as appropriate and start there as an offer price to any interested buyer? Determining the interest rate (the discount rate) is the trick. I am looking forward to a healthy discussion surrounding this topic.

Homework Answers

Answer #1

yes, we have to discount each and every cash flow.

Let's take example of $100 per month for next 5 years(60 months)
Let discount rate = R% per annum and r=R/100
now discount rate per month = r/12
now for monthly compounding, present value =
It is sum of a geometric progression series and can be easily calculated as

similarly, for $100,000 per year for next 5 years,
Present value=

Please do rate me and mention doubts, if any, in the comments section.

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