Unformatted text preview: per year, payable at the end of each of the five years.
The present value of the cash outflows is $729,859: This project has a positive net present value of $77,969 ($807,828 - $729,859). This suggests the
project’s returns exceed the 5% cost of capital threshold. Had the up-front investment been
$675,000 (instead of $575,000), the project would have a negative net present value of $22,031
($807,828 - $829,859). Download free ebooks at bookboon.com
29 Evaluation of Long-Term Projects Analytics for Managerial Decision Making 5.2 Impact of Changes in Interest Rates
Carefully consider the mathematics (or table values), and you will observe that higher interest rates
produce lower present value factors, and vice versa. You also know that the logic of making certain
investments changes with interest rates. Perhaps you have considered buying a house or car on
credit; in considering your decision, the interest rates on the deal likely made a big difference in
how you viewed the proposed transaction. Even a casual observer of macro-economic trends knows
that government policies about interest rates influence investment activity and consumer behavior.
In simple terms, lower rates can stimulate borrowing and investment, and vice versa.
To illustrate the impact of shifting interest rates, consider that Greenspan is considering a $500,000
investment that returns $128,000 at the end of each year for five years. The following spreadsheet
shows how the net present value shifts from a positive net present value of $39,183 (when interest
rates are 6%), to positive $11,067 (when interest rates are 8%), to negative $14,779 (when interest
rates rise to 10%). This means that the investment would make sense if the cost of capital was 6%,
but not 10%. In the above spreadsheet, formulas were used to determine present value factors. For example, the
“balloon” shows the specific formula for cell H17 -- (1/(1+i) ) -- where “i” is drawn from cell C17
which is set at 8%. Similar formulas are used for other present value factor cells. This simple
approach allows rapid recalculation of net pres...
View Full Document