We imagine that by investing in the purchase of bonds of a certain company that I guarantee 8% interest a year. This is not however the only safe investment I can make. ![]() Suppose you want to buy a property that today is worth $ 700,000 but in a year, after a renovation that will cost an additional $ 300,000, we are sure it will have a value of $ 1,200,000. The fair value of alternative investments enables you to locate a particular rate called cost opportunity of capital, interpretable as the rate of return expected by investors for an investment in stocks or bonds that have the same risk. The net present value of an investment project is given by the present value of the cash-flows that the project can generate over time less the value that would be obtained through alternative investments having the same degree of risk. a greater degree of risk leads to a reduction of the value in the future. yield waived by deciding to invest in that project rather than in a financial asset with the same risk Ģ. The higher the discount rate, the lower the present value of future cash-flows, so that present value and the discount rate are inversely proportional.īut, what is actually the discount rate r? As previously mentioned, there are two reasons why you discount cash-flows:ġ. The value 1/(1+r) t is called the discount factor and corrects cash-flow taking into account the period in which it is determined. In order to take account of the reasons described above, cash-flows must be "fixed" by multiplying each of them for a discount factor through the following formula: ![]() This means that, for the same amount between two cash-flows, the higher the inflation rate, the greater the difference between the value of a flow generated this year and one next year (and so on). In addition, we may need to take into account the effect of monetary inflation: the value of the currency is not constant over time, but decreases from year to year. For this reason, the higher the risk, the greater the difference between a cash-flow that we think we earn today than one of the same projected balance in the future.
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