occasionally cash flows may have to be discounted

Question

Occasionally cash flows may have to be discounted more often than once a year semi- monthly, daily, annually or quarterly.  The outcome of this is as fold

(i)  The number of periods raises

(ii) The discount rate applicable per period reduces.  The formula for computing the present value in case of shorter discounting period is:

PV = FV_n [1/(1 + k/m)]^n/m 

Here m = number of times per year discounting is done.

Illustration: Compute the present value of Rs. 10,000 to be obtained at the end of 4 years.  The discount rate is 10% and discounting is done quarterly.

Solution:

PV = FV₄ . PVIF k/m, m.n

= 10,000 . PVIF 3%, 16

= 10,000. 0.623

= Rs. 6230