Question

Consider the mixed streams of cash flows shown in the following? table

1)Find the present value of each stream using a 16?%discount rate.

2)?Compare the calculated present values and discuss them in light of the undiscounted cash flows totaling ?$175,000 in each case

1   $52,500   $17,500
2   $43,750   $26,250
3   $35,000   $35,000
4   $26,250   $43,750
5   $17,500   $52,500
Totals   $175,000   $175,000

Answer 1

Cash flow 1:

Year	Cash flows = CF	Discount factor = Df = 1/(1+16%)^Year	Present Value = CF x Df
1	52,500	0.862069	45,258.62
2	43,750	0.743163	32,513.38
3	35,000	0.640658	22,423.02
4	26,250	0.552291	14,497.64
5	17,500	0.476113	8,331.98
		Total of Present Value =	123,024.64

Cash flow 2:

Year	Cash flows = CF	Discount factor = Df = 1/(1+16%)^Year	Present Value = CF x Df
1	17,500	0.862069	15,086.21
2	26,250	0.743163	19,508.03
3	35,000	0.640658	22,423.02
4	43,750	0.552291	24,162.74
5	52,500	0.476113	24,995.93
		Total of Present Value =	106,175.92

Present value of Cash flow 1 i.e. 123,024.64 is more than the present value of Cash flow 2 i.e. 106,175.92

The cash flows in totality are same but Present Values differ. The difference occurs because the cash flow 1 has major cash flows which falls in early years compared to the Cash flow 2. The discounting factor reduces the intensity of the cash flow as cash flow goes far in future. Hence, we are observing different present values for the cash flows having same total amount of cash flows.