Page 441 - Corporate Finance PDF Final new link

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BRILLIANT’S Capital Budgeting 441

the other hand, the safety margin of project B Xÿgar Va’$ àmoOo³Q> B H$m goâQ>r ‘m{O©Z Ho$db 13.5% h¡&
is only 13.5% (13.5% of ` 1,15,500 is approx. (` 1,15,500 H$m 13.5% AWm©V² bJ^J 15,500)&
` 15,500). NPV method does not provide NPV ‘oWS àmoOo³Q> H$s goâQ>r ‘m{O©Z VWm [añH$ na
information about safety margin as well as the
amount of capital at risk. H¡${nQ>b H$s am{e Ho$ ~mao BÝ’$m°‘}eZ àXmZ Zht H$aVr h¡&>

Compounding Vs. Discounting H$ånmCpÊS>¨J ~Zm‘ {S>ñH$mCpÝQ>¨J
Compounding and discounting are two H$ånmCpÝS>¨J VWm {S>ñH$mCpÝQ>¨J ’$m¶Z|{e¶b ‘¡ZoO‘|Q>
important concepts used for decision making ‘| {S>[gOZ ‘oqH$J Ho$ {bE Cn¶moJ {H$E OmZo dmbo Xmo
in financial management. Both are just opposite
to each other and closely related like two sides _hÎdnyU© H$m°ÝgoßQ²>g h¢& XmoZm| EH$-Xÿgao Ho$ {~ëHw$b {dnarV
of a coin. h¢ VWm {g³Ho$ Ho$ Xmo nhbwAm| H$s EH$-Xÿgao go Ow‹S>o hþE h¢&
Compounding finds future value of present H$ånmCpÝS>¨J ‘| nr[a¶S> Ho$ {bE àoOoÝQ> d¡ë¶y H$s â¶yMa
value for a given period and rate of interest. d¡ë¶y VWm aoQ> Am°’$ BÝQ>aoñQ> kmV {H$¶m OmVm h¡& {S>ñH$mCpÝQ>¨J
Discounting finds present value of the same ‘| EH$ nr[a¶S> Ho$ {bE go‘ â¶yMa d¡ë¶y H$s àoOoÝQ> d¡ë¶y VWm
future value for that period and rate. They have aoQ> kmV H$s OmVr h¡& BZHo$ ~rM BÝdg© [aboeZ{en hmoVr h¡
inverse relationship and can be best illustrated VWm Bgo CXmhaU XoH$a AÀN>o go g‘Pm¶m Om gH$Vm h¡,
by demonstrating that if a present value of
¶{X {H$gr â¶yMa A‘mCÝQ> H$s àoOoÝQ> d¡ë¶y ‘| g‘mZ aoQ>
some future amount is using the same rate and
time period, the result will be the same amount VWm Q>mB‘ nr[a¶S> H$m Cn¶moJ {H$¶m OmVm h¡, n[aUm‘
of future value. â¶yMa d¡ë¶y H$m go‘ A‘mCÝQ> hmoJm&

Symbolically;
FV
n
FV = PV (1 + r) and PV  n
(1  r)
Suppose, we deposit ` 10,000 in a bank ‘mZ br{OE, ¶{X h‘ {H$gr ~¢H$ AH$mCÝQ> ‘|
@ 10% interest compounded annually and we ` 10,000 {S>nm°{OQ> H$aVo h¢ {OgH$m dm{f©H$ H$ånmCÝS>
want to know how much will it grow after 5 BÝQ>aoñQ> @ 10% h¡ VWm ¶h OmZZm MmhVo h¢ {H$ 5 df©
years, our approach is towards compounding ~mX h‘ {H$VZm J«mo H$a|Jo& h‘mam EàmoM H$ånmCpÝS>¨J hmoJm
and we are willing to calculate future value of
VWm h‘ àoOoÝQ> d¡ë¶y H$s â¶yMa d¡ë¶y Ho$ëHy$boQ> H$a|Jo&
a given present value.
FV = 10,000 (1 + 0.10) = `16,105
5
Let us take just opposite example. If a A~ BgH$m {dnarV CXmhaU boVo h¢& ¶{X EH$ H$ånZr
company offered to pay us after 5 year ` 16,105 5 df© ~mX ` 16,105 XoZo H$m Am°’$a H$aVr h¡ ¶{X
and we want to know how much money we
BÝQ>aoñQ> aoQ> 10% hmo Vmo h‘ ¶h OmZZm Mmh|Jo {H$ h‘|
should deposit in company if rate of interest is
10%, now our approach is discounting and we {H$VZm A‘mCÝQ> O‘m H$aZm hmoJm, A~ h‘mar EàmoM
want to know the present value of the future {S>ñH$mCpÝQ>¨J hmoVr h¡ VWm h‘ â¶yMa A‘mCÝQ> H$s àoOoÝQ>
value. d¡ë¶y OmZZm Mmh|Jo&

16,105
PV  5  ` 10,000
(1 0.10)