Question

Question Help Problem 4-65 (algorithmic) Are the following cash flow diagrams economically equivalent if the interest rate is 12% per year? MMM The left hand diagram's discounted value at the EOYO IS SIM (Round to three decimal places)

Answer 1

To calculate whether they are economically equivalent, I will calculate their present worth:

Cash Flow 1 (Left Cash Flow):

You will get 7M in one year, Present value is [7 / (1 + 0.12)1] = 6.25

You will get 8M in two year, Present value is [8 / (1 + 0.12)2] = 6.37

You will get 6M in three year, Present value is [6 / (1 + 0.12)3] = 4.27

You will get 5M in four year, Present value is [5 / (1 + 0.12)4] = 3.17

Total present value = 6.25 + 6.37 + 4.27 + 3.17 = 20.07M

Cash Flow 2 (Right Cash Flow):

You will get 7M in one year, Present value is [7 / (1 + 0.12)1] = 6.25

You will get 7M in two year, Present value is [7 / (1 + 0.12)2] = 5.58

You will get 7M in three year, Present value is [7 / (1 + 0.12)3] = 4.98

You will get 7M in four year, Present value is [7 / (1 + 0.12)4] = 4.44

Total present value = 6.25 + 5.58 + 4.98 + 4.44 = 21.26M

Thus these both cash flow are not economically equivalent.

Discounted value of left cash flow is 20.07M