Here we use the discount factor F = [(exp(r) -1)/r][exp-(rn)] (Assume F = 0.763) to examine the profitability of an investment with a discounted cash flow analysis. An energy investment is made by a company with initial cost $11,000,000. Depreciation is $1,000,000 per year, the project life is 10 years, and the investment has no salvage value at the end of the project.
Suppose this investment generates $500,000 profit the first year, $600,000 the second, $800,000 the third, $900,000 the fourth, and $1,000,000 per year in the fifth every year from the fifth to the tenth year - the end of the life of the investment.
With the help of the continuous discount factor F found in the last question, we can evaluate a Discounted Cash Flow, which is an interest rate that makes the sum of the investments and returns on the investment zero at the end of the life (10 years) of the project. This is the interest rate of return on the money invested in this project.
To do so, make a table that covers the period of 10 years for a given interest rate. When we have the Sum over the Years of the Present Value = 0, we have identified the appropriate interest rate.