Question

This is not a graded discussion. However if you participate you will be provided with feedback.

Using worked examples, for each of the following explain the differences between:

• simple interest and compound interest
• internal rate of return and net present value
• inflation and depreciation

Answer 1

A. Simple rate of return is not taking the effect of earlier interest when it is providing interest so it is not providing for the effect of the compounding and it will always be uniform in nature.

Compound rate of return will always take of effect of the earlier interest and it is always known as interest on interest and it will take the effect of the compounding and it will not be uniform in nature and it will be changing with the time period and it will be growing with the time period other things remaining constant

For example , if there is a rate of interest of 8% on 1000, simple interest will always take 800 for every year whereas compounding rate of interest will be adding the 800 into the principal amount and then calculating the interest for the next year.

B. Internal rate of return is rate of return in percentage terms whereas net present value will be providing return in dollar terms.

Internal rate of return is not adopted when there is no uniformity in the cash flow and the cash flow streams are having various outflows where as NET present value can calculate efficiently even if there are various cash outflows.

Net present value of the project is more preferred method of acceptance than internal rate of return.

for example internal rate of return will be 16% that has net present value will be $16000.

C. Inflation will be reflecting the increase in the prices of goods and services where are depreciation will be reflecting the decrease in the prices of goods and services.

inflation is always preferred by investors whereas deflation and appreciations are not preferred as wealth are distracted.

there will be quantitative tightening policy during inflation and there will be quantitative easing policy during depreciation and deflation