r stands for interest rate,
n stands for number of years.In other words, Compound Interest formula will help us to find Future Value of
money.For example:
At the rate of 10% PA, the Future Value of Rs.100 at the end of theI Year = Rs.110
II Year = Rs.121
III Year = Rs.133.10
IV Year = Rs.146.40 and so on.By reversing the compounding interest formula, we can find the present value of
money receivable in future i.e.’
1
PV = FV X
(l + r)n1.6. For example, if 'X' invests Rs.100 on 01.01.2001 at rate of 10% P.A. and he
expects a return of Rs.146.40 at the end of the IV year. In terms of the cost of
the money i.e., interest rate of 10 % P.A., the present value of Rs.146.40
receivable at the end of the fourth year is Rs.100 only. [It may be less than
Rs.100, if the negative aspect of inflation effect is calculated. But we are not
focusing on inflation accounting]1.7. Every investor will expect returns higher than the Investment + Cost of
Investment. The cost of investment is nothing but interest rate. Some
investors expect returns higher than the present returns, i.e. more than the
present opportunity. This is called opportunity cost based approach to
calculate net returns. Opportunity cost will be the cost of capital to measure
the cost of cash outflow and cash inflow. Therefore, the cost of capital to
calculate the net return varies from person to person, firm to firm and
industry to industry. The Planning Commission of Government of India
fixes the cost of capital at 12% to calculate the net returns for all government
projects, barring some Agro-based industries, like sugar Factories, where the
deficiency in returns is subsidized because of social weightages.1.8. The cost of capital i.e., in the form of interest rate or in the form of
opportunity cost is taken as Discount Factor to calculate the present value of
costs and the present value of returns. The difference is the net present value:1.9. To save time, there are ready made: SPPWF table and USPWF Table.