(b) Ori’s marketing director suggests that it is incorrect to use the same discount rate each year for the investment in packaging as the early stages are riskier and should be discounted at a higher rate. Another board member disagrees saying that more distant cash flows are riskier and should be discounted at a higher rate. Discuss the validity of the views of each of the directors
(b) Ori’s marketing director suggests that it is incorrect to use the same discount rate each year for the investment in packaging as the early stages are riskier and should be discounted at a higher rate. Another board member disagrees saying that more distant cash flows are riskier and should be discounted at a higher rate. Discuss the validity of the views of each of the directors.
The discounted methods of Capital Budgeting such as, NPV or Net Present value method use a discount rate to calculate the present value of future cash flow based on time value of money concept.
NPV normally uses a fixed discount rate during the life of the project.
However, this does not consider the extent of uncertainty involved in cash flows in different time periods.
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