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Present value 4 (and discounted cash flow) Video Lecture - Economics

FAQs on Present value 4 (and discounted cash flow) Video Lecture - Economics

1. What is present value and how is it calculated?
Ans. Present value refers to the current worth of a future sum of money, taking into account the time value of money. It is calculated by discounting the future cash flows using a discount rate. The formula for present value is: PV = CF / (1 + r)^n, where PV is the present value, CF is the future cash flow, r is the discount rate, and n is the number of periods.
2. What is discounted cash flow (DCF) analysis and why is it important?
Ans. Discounted cash flow (DCF) analysis is a financial valuation method used to determine the intrinsic value of an investment by estimating the present value of its future cash flows. It is important because it helps investors and analysts assess the attractiveness of an investment opportunity, taking into account the time value of money. DCF analysis allows for a more accurate evaluation of the potential returns and risks associated with an investment.
3. How does the discount rate affect the present value of cash flows?
Ans. The discount rate plays a crucial role in determining the present value of cash flows. A higher discount rate reduces the present value of future cash flows, while a lower discount rate increases it. This is because a higher discount rate reflects a higher required rate of return, which reduces the value of future cash flows. Conversely, a lower discount rate indicates a lower required rate of return, resulting in a higher present value.
4. Can present value be negative?
Ans. Yes, the present value can be negative. A negative present value occurs when the future cash flows are expected to be lower than the initial investment or when the discount rate is higher than the expected return. This implies that the investment is not expected to generate a positive return and is considered unfavorable.
5. What are some limitations of using present value and discounted cash flow analysis?
Ans. While present value and discounted cash flow analysis are widely used in financial decision-making, they have certain limitations. Some of these limitations include uncertainty in estimating future cash flows, difficulty in determining the appropriate discount rate, sensitivity to small changes in inputs, and the inability to account for non-financial factors. Additionally, DCF analysis assumes that cash flows will be reinvested at the discount rate, which may not always be realistic in practice.
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