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Unformatted text preview: firm is offered the following investment opportunity: in exchange for $500 today, you will receive $550 in one year. If the
interest rate is 8% per year, then
PV(Benefit) ($550 in one year) ÷ (1.08 $ in one year/$ today)
$509.26 today This PV is the amount you would need to put in the bank today to generate $550 in one
year ($509.26 1.08 $550). In this case, the present value is the value today of the
benefit that is to be received in one year.
Once the costs and benefits are in present value terms, we can compute the investment’s NPV:
NPV $509.26 $500 $9.26 today But what if you don’t have the $500 needed to cover the initial cost of the project? Does the project still have the same value? Because we computed the value using
competitive market prices, it should not depend on your tastes or the amount of cash
you have in the bank. If you don’t have the $500, suppose you borrow $509.26 from
the bank at the 8% interest rate and then take the project. What are your cash flows
in this case?
Today: $509.26 (loan) $500 (invested in the project)...
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This note was uploaded on 02/07/2014 for the course MIS 304 taught by Professor Mejias during the Spring '07 term at University of Arizona- Tucson.
- Spring '07