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Investment appraisal – Discounted cash flow techniques

Question 1

Compounding

An investment of $500 is to be made today in an account earning 5% interest
per annum. What will be the value of the account after 3 years?

Either:

Take each year separately:

Year 1 $500 × 5% = $25 interest. Value at end of yr = $525.00

Year 2 $525 × 5% = $26.25 interest. Value at end of year = $551.25

Year 3 $551.25 × 5% = $27.56 interest. Value at end of year = $578.81

Or:

n
Use compounding formula F = P (1 + r)

P = $500, r = 0.05, n = 3

3
F = $500 × 1.05 = $578.81

Illustrations and further practice

Now work through illustration 1 and try TYU 1 from Chapter 3

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