A planned factory expansion project has an estimated initial cost of $800,000. Based on a discount rate of 20 percent, the present value of the future cost savings from the expansion is $843,000.
To yield exactly a 20 percent return on investment, the actual investment expenditure should not exceed the $800,000 estimated cost by more than what amount?
Present value refers to the value today of future cash flows. Present value is not simply the sum of the future cash flows. Rather, present value considers the time value of money in its calculations. For instance, $100 is worth more to you today than in five years from now. Thus, present value calculations would discount the $100 back five years using an established discount rate.
Answer and Explanation:
We find that when the discount rate, also known as the required return, equals 20%, the present value equals $843,000. Thus, to yield exactly a 20 percent return on investment, the actual investment expenditure should not exceed the $800,000 estimated cost by more than the $43,000 difference between the project's present value and its cost.
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from Introduction to Business: Homework Help ResourceChapter 24 / Lesson 15