Present Value

Question A

Present Value 2 ,600 x 0 .97007 2 ,522 .18

Question B

Account A

4 ,000 x 0 .96154 3 ,846 .16

Account B

Year 1 7 ,000 x 0 .96154 6 ,730 .78

Year 2 7 ,000 x 0 .92456 6 ,471 .92

Present Value 13 ,202 .70

Question C

Projected Income

Year 1 : 310 ,000 x 0 .93458 289 ,719 .80

Year 2 :520 ,000 x 0 .87344 454 ,188 .80

Year 3 :490 ,000 x 0 .81630 399 ,987 .00

Present

Value 1 ,143 ,895 .60

Question D - Application of Discount Rates

The method with which the three business plans presented will be evaluated is based on the concept of the time value of money . It is important that one understands this concept before assessing the respective discount rates . This concept is based on the premise that 100 today are more valuable that 100 next year . This arises from a number of logical factors present in the business environment . The first economic factor that comes to mind is inflation . Over time money loses its purchasing power due to rising prices leading to a loss in its value . Therefore in practice management have to consider such factors in project and investment evaluations by adopting appropriate discount rates . However this has no relevance over the business plans because the inflation will be fairly the same for all plans , unless a hyperinflation arises , which is rarely the case

In economics lost alternatives are assessed and an opportunity cost is to such lost options in business evaluation . For instance , if a person endows 10 ,000 today in assets to commence trading as an electronics retailer , he is losing the opportunity from having this money available for other business opportunities , like for example investment in a 5 savings account . This opportunity cost1 thus justifies the proposition that 100 today are more valuable that 100 next year . In this respect we have to determine the discount rate of the business plans in line with the opportunity cost arising from the financial requirement of the project

The Ice Dreams plan will entail a financial requirement of 52 ,010 while the Edgar Risk Ventures Ltd business proposal shall request 61 ,000 , and the Interstate Travel Center capital project demands 2 ,750 ,000 . As we can see the project with the highest initial financial requirement is the latter one , the Interstate Travel Center This will thus carry the highest opportunity cost and should therefore be assessed a higher discount rate when compared with the other two . On the contrary , the Ice Dreams plan comprises the lowest financial commitment , thus taking lower money from the providers of finance resulting in a diminished opportunity cost . As a result , the lowest discount rate should be applied to this project

References

Brockington B . R (1996 . Financial Management . Sixth Edition . London DP Publications

Pike R Neale B (1999 . Corporate Finance and Investment . Third Edition . England : Pearson Education Limited

1 Is an economic measure of the income contribution foregone...