NPV question

CFA Level I Corporate Finance
#1

Hi Nocturn folks,

could you please help me understand why would a project with most of its cash flows ocurring later in its life, have a steeper slope? Wouldnt this mean the cost of capital is lower? It doesnt make sense to me.

thank you in advance

L’Hibou

#2

Early cash flows are discounted a little; late cash flows are discounted a lot.

Consider $1 one year from today. Today, it’s worth:

  • $0.9901 discounted at 1%
  • $0.9091 discounted at 10%
  • $0.8333 discounted at 20%

Consider $1 ten years from today. Today, it’s worth:

  • $0.9053 discounted at 1%
  • $0.3855 discounted at 10%
  • $0.1615 discounted at 20%
#3

Because cash flow that is occuring later in the project phase will be discounted over multiple period of times, and thus it will reduce the value by the time you arrive at the NPV or PV.

#4

Thank you so much Magician and Olaji! I should have taken a picture of all the drawings i made to understand this! Anyway thank you both, that makes a lot of sense :slight_smile:

have a good day!

#5

My pleasure.

#6

You are welcome.