Marketing

Corporate Finance

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Corporate Finance

Present value is the discounted amount of cash for a certain period of time. The present value shows the value expected at the end of a given period (Delaney & Whittington, 2005). The applicable formula in this case is:

PV= CF(1+r)1+ CF(1+r)2+…+ CF(1+r)n

To measure the implication of the effect of negative three scenarios can be applied. In this case the discounting factors is said to be negative when the effective interest rate is negative. In the three scenarios, equal amount cash flow and periods can are applied.

Scenario 1:

An investment expects a cash inflow of $ 20,000 per years for the next 3 years. The interest rate of the investment is 10% per annum.

The following is the present value of the investment

Pv = $ 20, 000 / (1 + 0.1)1 + $ 20, 000 / (1 + 0.1)2 + $ 20, 000 (1 + 0.1)3 =

$ 20, 000/ 1.1 + $ 20, 000/ 1.12 + $ 20, 000/ 1.1 3

18, 181. 8 + 16, 528.9 + 15, 026 =$ 49, 735.9

Scenario 2: an interest rate of 1 % per annum while the periods remain the same and the cash flow remains the same.

Pv = $ 20, 000 / (1 + 0.01)1 + $ 20, 000 / (1 + 0.01)2 + $ 20, 000 (1 + 0.01)3 =

$ 20, 000/ 1.01 + $ 20, 000/ 1.012 + $ 20, 000/ 1.01 3

$ 19, 802 + 19, 606 + 19, 417 = $ 58, 825

Now assuming an interest rate of – 10 % while other factors remaining constants

Pv = $ 20, 000 / (1 - 0.1)1 - $ 20, 000 / (1 - 0.1)2 + $ 20, 000 (1 - 0.1)3 =

$ 20, 000/ 0.99 + $ 20, 000/ 0.99 2 + $ 20, 000/ 0.99 3

20, 202 + 20, 406 + 20, 612 = $ 61, 220

It is clear that as interest rate reduces the present value of an investment increases. At a negative interest rate, the present value is higher than when the interest rate is 1 % which is higher than when the interest rate is 10 %. It is therefore clear that the interest rate at negative discount rate is relatively higher.

Reference

Delaney, P. R., & Whittington, R. (2005). Wiley...