Question

You plan to analyze the value of a potential investment by calculating the sum of the present values of its expected cash flows in the future. Which of the following would lower the calculated present value of the investment?

The discount rate increases.

The riskiness of the investment’s cash flows decreases.

The total amount of cash flows remains the same, but more of the cash flows are received in the earlier years and less are received in the later years.

The discount rate decreases.

Answer 1

The present value of invested is lowered when
1. Correct option The discount rate increases because the future cash flows are discounted so (1+ discount rate) is at the denominator. So higher the denominator lower is the present value.

All other options are incorrect (option 2 & 4 are incorrect) because if riskiness decreases then discount rate will decrease and since ( 1+ discount rate is at the denominator lower the denominator higher the present value of investment. Option 3 is incorrect higher cash flows or lower cash flows might result in higher or lower npv depending on discount rate whether it is lower than crossover rate or higher than cross over. Cross over rate us the rate at which both the higher initial cash flow and lower initial cash flows which are same NPV

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