Discounted Cash Flow: The Money that Makes Money
Ahmed A Morsy
Working in a market driven by loans, bailouts and investments, it is essential for a company to understand the various methods employed in operating a loan. It is not necessarily for the sole purpose of acquiring a loan, but it is also helpful in understanding how investments will turn out whether by lending others or inputting cash in businesses as forms of investment. There are various elements than need to be considered in the cash flow process that can help identify the benefits of a certain investment or decide against investing in a certain firm. Future value, compounding periods, present value, loan amortization and rate of return of an investment (Ross, Westerfield and Jaffe, 2013). By understanding and employing the above elements, a firm or person can maximize their investments and minimize their losses.
Many individuals who have saved a decent amount of money prefer to invest their moneys in one way or another. Some like to invest in a bank’s savings account where a fixed interest rate is added onto the amount. Others like to invest in start-up companies or existing small businesses that need an investor for growth. In the next few paragraphs, light will be shed over the various elements that can help the investor identify the perfect investment outlet and the some of the methods employed in regaining the investment. For simplicity purposes, a hypothetical investor, Ben, will be employed who is attempting to invest $10,000.
For our purposes, we will assume that Ben would like to invest his $10,000 into a start-up company that promises to pay back the loan in five years with an interest of 10%. For Ben to calculat...
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...ar 3: $2000 + 10% interest on principle = $2600 $4000 principle remain
Year 4: $2000 + 10% interest on principle = $2400 $2000 principle remain
Year 5: $2000 + 10% interest on principle = $2200 $0000 principle remain
This above breakdown will show that Ben’s loan will be paid off in five years as anticipated with the interests decreasing. If the values are added, it will be noticed that Ben’s final profit is $3000 and not the $6105.10 anticipated in the above future value calculations. As a reminder for this difference, it is important to remember that first calculation was based on continuous investment year by year which allows the interest to compound and get applied to the preceding principle + its interest wherein the above calculation shows the simplicity of a loan wherein the principle as a whole has an interest rate and a payment plan is applied.
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