As shown on slide 6 of chap4.ppt there are two ways to calculate the PV(NPV) using the mid-year convention; i.e. rather than assume all cash flows occur at year end, we sometimes assume that all cashflows occur mid-year. Confirm that there are two ways to do this that are equivalent.
Assume the project is already up and running and produces cash flows of $50, $70 and $80 for the next three years; the cost of capital is 10%.
- What is the PV/NPV of the three years of cash flows assuming the end of year convention, e.g. $50 at t=1, ,$70 at t=2 and $80 at t=3?
- Using the adjustment on slide 6, what is the NPV/NPV using the mid-year convention, e.g. $50 at t= 0.5, $70 at t=1.5 and $80 at t=2.5?
- Use discount factors, i.e. 1/(1+r)^t to confirm the answer using the adjustment on slide 6 for the NPV with mid-year cash flows.