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•Six Greatest Financial Necessities of Business Life 69
Which would you choose?
Both of these projects give the same total profit over five years but I imagine
that, all other things being equal, most people would prefer to undertake project 2
since the returns arise earlier.
That problem was easy to solve, but what if the return on project 2 in year five
was only £2,000? Would the reduced total profit on project 2 now make it less
desirable than project 1 or is the advantage of early payback great enough to over-
come the disadvantage of reduced profit?
The mechanics of DCF
To arrive at a method of dealing with this, consider the following:
You have inherited £10,000 from Aunt Mary. Unfortunately, she had heard
that you are liable to spend money fairly freely, so her will says that you cannot
receive the cash until your 30th birthday. You are 27 today (happy birthday!)
Aunt Mary was actually fairly well informed. You are desperate to get this money
before the 3.30 at Aintree and you have found a friendly banker who will advance
you part of the money.
The interest rate is 10% per annum and she is prepared to advance you an
amount £A such that with interest you will owe her exactly £10,000 in three years
time. How much can you get? See if you can work it out before you turn the page to
the solution.
