Changes

In its simplest form, Net Present Value applies a discount rate to a future cash flow number and the product is the Net Present Value.

In its simplest form, Net Present Value applies a discount rate to a future cash flow number and the product is the Net Present Value.

The discount rate may have many components; Internal Rate of Return (IRR), Cost of Capital, Cost of Debt, Risk, and so on.

The discount rate may have many components; Internal Rate of Return (IRR), Cost of Capital, Cost of Debt, Risk, estimated inflation and risk.

 

Suppose you lent $100.00 to Person A.  It is to be repaid within one year.  You would like a return of 5% on your money you expect inflation to be 2%, and your assessment of risk for this person leads you to add 1% to the discount rate.  This means you would assign a discount rate of 8% to this loan.  If this person approached you suggesting, I will give you $90.00 today to discharge my loan, you would counter that you needed at least $92.59.  (92.59 x 1.08 = $100.00)

 

Usually a corporation will use a Weighted Average Cost of Capital as a discount rate when NPV is the appropriate method of evaluating an invesment or capital expenditure.

 

[[Category:finance]]

[[Category:finance]]