This topic has 3 replies, 2 voices, and was last updated 4 years ago by Cath.

Hi Cath
I was doing a question and came across something I just wanted you to clarify.
P Ltd intends to purchase a machine that will cost 18,000. the machine will save operating cost of 12,000 in the first year. Operating cost are budgeted to increase in year 1 by 8%/ Both the annual average rate of inflation and the real cost of capital are 10%. The machine has a 2 year life with a salvage value receivable at the end of the year 3 of 3,000. What is the NPV of the proposed investment
Solution…
Year Cash flows DF ( 21%)
0 (18,000) 1
1 (12,000) ……
2 (12960)(adjusted for increase in expenses- 8%) …….
2( scrap) (3000) ….
Now- initially I struggled to get the DF to be 21%. I initially thought it was 10% and then I peaked at the answers and say that the DF was 1.1%*1.1% and then wondered why.
I know that that the money rate should be applied to inflated value when trying to determine the NPV.
(1 +money rate)- (1+real rate)* (1+inflation rate)
which explains the (1.1% *1.1%)= 1.21% where 21% equals the money rate…my question is how do you know when to apply the money rate or the real discount rate? My book says the money rate is used when inflation occurs and real rate is when there is no inflation. but why? whats the theory behind it… the reason.
Thanks from Abi
Hi,
The way to remember this is
Inflated cash flows : we use inflated discount rate (i.e. The money rate)
Whereas Real cash flows use the real rate
As you say- the money rate has inflation in its composition. i.e. (1+m)=(1+infllation rate ) (1+ real rate)
So we use the rate with inflation in it (our money rate) to discount inflated cashflows
If you have cash flows in REAL terms – i.e. Inflation is stripped out and values are all given in current /time 0 terms – then we need to use the real rate to discount.
Inflated rate with inflated flows
Real rate with real flows
Hope that helps?
Thats great – Im glad that helps … I will get back to your other questions asap….

Assets used to produce goods. Farm land is a major example of real capital: the farmer uses this asset to produce commodities, which he then sells to make a profit. See also: Financial capital. Financial Markets: Capital vs. Money Markets The Money Market The money market is a good place for individuals, banks, other companies, and governments to park cash for a short period of time. Most of the time, how to classify gains and losses from selling an asset is fairly straightforward. But there are some gray areas that require a closer look at the facts and circumstances, especially when real estate is involved, as a couple of recent cases demonstrate. Why It Matters Distinguishing between capital and ordinary gains and losses is an important issue for two reasons: 1.

Venture Capital isn’t the only answer. But it’s one of very few answers if you want to take your business to a materially different level. Many other financial routes are closed off in the current climate and non financial adjustments, whilst potentially positive, will not have the same impact.

Real Capital Vs Money Capital Definition

Recruitment attracts entrepreneurs. The UK is without doubt one of the global hubs for recruitment. There are more agencies in London than there are in the whole of the US, but that does make it difficult to stand out from the crowd.

Venture Capital vs Bank Loans

Taking a significant step forward with a business usually requires some sort of investment and in general there are 2 recognised financial routes. The first is a bank loan and the other is venture capital (or private equity).

If you pursue the bank loan route bear in mind, as a recruitment company is not an asset backed company (apart from its debtors which normally attract finance for working capital) it’s never been easy to borrow money against a recruitment companies future profits, given that the assets leave the office at 6pm every night and hopefully return the next day.

Traditional banking has never been more difficult than it is now. There are many reported cases in the last few years where companies have borrowed from a bank, have been able to repay the interest but have been in breach of the long list of banking covenants. These covenants are scrutinized intensely by super-keen analysts, who seem all too ready to press the alarm bell, sending in the bank’s friendly business support team. In turn, this often leads to them calling in the administrators… and the rest is history… in many cases.

Undoubtedly the dangers of obtaining bank loans have never been greater, peppered with high charges, conditions, key ratios and draconian penalties, if you can get past the hurdle of getting one in the first place. App to upload bills and earn money.

Real Capital Vs Money Capital Vs

The alternative method of raising finance is by attracting an investor such as a venture capitalist, whereby you sell a piece of your equity in return for long term investment. However, this is hardly a piece of cake either. Nevertheless, it’s generally regarded as the best credible alternative to a bank loan.

Capital One Money

Benefits of Venture Capital Specialist;

Knowledge; If you choose a venture capitalist with experience, or preferable a focus, in your chosen market you will gain a partner with considerable insights and practical experience.

Advice & Mentoring; Their expertise will be extremely useful in terms of acquisition or strategic advice, management infrastructure, succession planning and of course exit. If you haven’t been part of an exit before, an experienced partner will be invaluable, both with practical advice, business preparation and contacts in the market. They’ll then not only add value in general but will unlock the value of the equity, a specific skill which many owners don’t yet have, because they haven’t needed to.

Real Capital Vs Money Capital Management

Understanding; The right VC partner will take the time to understand your business. If they have experience of the recruitment industry, they will understand the cause and effect of recruitment specific issues such as seasonality, payment cycles and drop-outs. Therefore, they will make more informed decisions and will understand that the assets in the business are the people.

Additional Financing; If additional financing is required in the future, then a VC will provide important support either via increasing bank lending or through investing further themselves.

Contacts and Networks An investor, especially one well connected to the recruitment industry, should be able to utilise their wide range of contacts through their business networks, from PR agencies to banks, from accountants to marketeers. Everyone who can help take your business to a new level and beyond.

Summary
Attracting investment can accelerate your company’s growth exponentially. If chosen wisely, it can help support your plans and take some of the strain from the senior management.

Traditional bank loans are difficult to obtain now and are inflexible. I would also argue that they are light on additional benefits. VC’s can add real value from their experience and contacts, especially if they are industry experienced professionals who have held executive management roles and have practical experience of adding value. In addition, where a VC is investing it’s own money you can be sure that their commitment to wealth creation for all equity stakeholders will be 100%.

Source by Philip M Marks