1*
2* 10* -
1
2 17 18*
1
20, 21 20, 21, 23
4*
3* 5* 11* 18* -
8, 9
6 7 14 11 12*
4, 5
2 3 9 8 10, 11
*Book preference
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6
40
7
30
8
20
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For example, a firm is considering a one-year project that requires an investment of Rs. 1,000 in fixed assets and working capital at time 0. The project is expected to generate a cash inflow of Rs. 1200 at the end of year 1. This is the only cash inflow expected from the project. Project is financed by debt carrying an interest rate of 15% maturing after 1 year.
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Financing Side Time Cash Flow 0 + 1,000 1 - 1,150 Cost of capital: 15%
Investment Side Time Cash Flow 0 - 1,000 1 + 1,200 Cost of return: 20%
Note that the cash flows on investment side do not show cost of financing (interest in our example). Financing costs are included in the cash flows on the financing side, which reflects in cost of capital. Cost of capital is used as a hurdle rate against which rate of return on investment side is judged. 8 / 23
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Project cash flow for year t = Cash flow for the firm with the project for year t Cash flow for the firm without the project for year t
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Initial investment
Annual net cash flows Terminal cash flows
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60
40
40
129.42
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1
40 0 40 30
2
40 60 100 30
3
0 40 40 30
4
0 40 40 30
NPV, 10%
129.42 106.96 236.38 215.10
Correct procedure to compare NPVs of the projects for equal periods of time.
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