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Why is there inverse relationship between NPV and discount rate?
Higher discount rates mean cash flows that occur sooner are more influential to NPV. Since the earlier payments tend to be the outflows, the NPV profile generally shows an inverse relationship between the discount rate and NPV. The discount rate at which the NPV equals 0 is called the internal rate of return (IRR).
What is the relationship between present values and interest rates?
The higher the interest rate, the lower the PV and the higher the FV. The same relationships apply for the number of periods. The more time that passes, or the more interest accrued per period, the higher the FV will be if the PV is constant, and vice versa.
Why is the net present value of a capital budgeting project equal to zero when its internal rate of return is used as a discount rate?
IRR is a discount rate that makes the net present value (NPV) of all cash flows equal to zero in a discounted cash flow analysis. IRR calculations rely on the same formula as NPV does. Keep in mind that IRR is not the actual dollar value of the project. It is the annual return that makes the NPV equal to zero.
Why does higher discount rate lower present value?
Because cash flow in the future carries a risk that cash today does not, we must discount future cash flow to compensate us for the risk we take in waiting to receive it. A higher discount rate implies greater uncertainty, the lower the present value of our future cash flow.
Why do we discount when calculating present values?
Discounted present value allows one to calculate exactly how much better, most commonly using the interest rate as an input in a discount factor, the amount by which future payments are reduced in order to be comparable to current payments.
Is it better to have a higher or lower present value?
Investors and businesses commonly use PV when assessing the rate of return for investments or projects. Investments with a higher discount rate will have a lower present value, while those with a lower discount rate will have a higher PV.