TAN is considering 3 cash flow:
Cash flow A: receive 90 million VND today and then receive 20 million VND every year for next
five years.
Cash flow B: receive 10 million VND every year, forever, starting today.
Cash flow C: pay 30 million every year for five years, with the first payment being next year, and
then subsequently receive 50 million VND every year for 20 years.
Know that discount rate is 8%. Which cash flow should TAN choose?
To determine which cash flow TAN should choose, we need to calculate the present value of each cash flow and compare them. The present value represents the current value of future cash flows, taking into account the time value of money.
Let's calculate the present value of each cash flow using the discount rate of 8%.
Cash flow A:
The initial cash flow of 90 million VND received today can be considered the present value itself.
Cash flow B:
To calculate the present value of the perpetual cash flow, we can use the perpetuity formula:
Present Value = Cash Flow / Discount Rate
Present Value of cash flow B = 10 million VND / 0.08 = 125 million VND
Cash flow C:
First, we calculate the present value of the payment of 30 million VND for the next five years. This represents an ordinary annuity, and we can use the annuity formula:
Present Value = Payment × (1 - (1 + Discount Rate)^(-Number of Periods)) / Discount Rate
Present Value of payments for cash flow C = 30 million VND × (1 - (1 + 0.08)^(-5)) / 0.08 ≈ 113.35 million VND
Next, we calculate the present value of the subsequent cash flows of 50 million VND for the next 20 years. Again, we can use the perpetuity formula:
Present Value = Cash Flow / Discount Rate
Present Value of subsequent cash flows for cash flow C = 50 million VND / 0.08 = 625 million VND
Total present value of cash flow C = Present Value of payments + Present Value of subsequent cash flows
= 113.35 million VND + 625 million VND = 738.35 million VND
Now, let's compare the present values of each cash flow:
Present Value of cash flow A = 90 million VND
Present Value of cash flow B = 125 million VND
Present Value of cash flow C = 738.35 million VND
From the calculations, we can conclude that cash flow C has the highest present value. Therefore, TAN should choose cash flow C as it provides the maximum value considering the 8% discount rate.