Question

Usually we compute present values using a constant interest rate. But we know that interest rates vary over time, and it is impossible to know what the interest rate will be in 10 or 20 years. Why is using the current interest rate a good approach? Or would we be betteroff to simply ignore cash flows arriving beyond the period for which we have reasonable interest rate estimates? Explain your answer.

Answer 1

Using the current interest rate is a better estimate and it will be offering with uniformity in the calculation as it will also offer with flexibility for the company.

we know that current interest rate is not going to be similar for the next 20 years but when we are calculating the cash flow the associated with the firm,then we will be ascertained and the risk associated with the cash flow and the changes in the microenvironment so we will be trying to adjust the cash flow accordingly so that even if we are using the uniform interest rate at the current interest rate,we will not be getting affected to a large extent and we will be calculating our estimates most accurately so we will rather try to adjust the cash flows associated with the project in a better manner by adjusting risk associated with operating in future or benefits associated with the operating in future so we will be trying to quantify the risk in cash flows associated with the project rather than interest rate and we should be using any uniform interest rate as that will be offering us with Better calculations and Better estimates and we should not be leaving cash flows beyond a certain estimate when the interest rate are not fairly ascertainable.