There is a universal appeal to using NPV - net present value as the key indicator of profitability. Forget the investor for a second, all of us no matter what profession we engage in regardless of education, skill, race, gender, religion, sexual orientation, counrty of origin know that the more of money we have the more happy it makes us. Thus we all know about NPV - without even knowing it's name since a net present value is the money amount we stand to gain or lose when undertaking an economic activity. This is one reason you would see a mile long queue of people at the local grocery store in New York State who are all willing to buy a one dollar lottery ticket in hopes to gain a net present value in amounts of millions of dollars.
But then finding net present value requires much more than what they taught Melissa who went to CUNY - City University of New York, or Matthew who went to UCLA - University of California at Los Angeles to study Business Management.
To begin investigating net present value, you would have to understand what they call an annuity that happens to be a series of periodic payments or receipts. Your monthly utility or phone bill is an example of an annuity so is the annual college tuition of your child. Annuities have durations and timings, for instance a house rent is due at the start of month whereas a utility bill is due at the end of the months once service has been consumed. This divides the annuities into an annuity due (start of period payments) and ordinary annuity (end of period payments). There is a slightly different type of annuity where payments do not begin immediately at the start or end of period, such payments are delayed by a length of time. Such annuities are referred to as a deferred annuity. Now you are more likely to pay the house rent or utility bill for a longer period of time as you must pay the cost of living. On the other hand, you would only be paying for your children's college fee for a maximum of 4 or 6 years. As the duration of earning college degrees are of short durations as compared to consuming services or goods that you need on a daily or periodic basis as long as you live.
Money is only lent when the lender can receive a sum that is higher than the amount that was loaned to offset the opportunity cost had the lender decided to keep the money for herself. She would only be willing to let go of the money at present if you could receive a sum of money that will include her opportunity cost. But she would only be lending if it is for certain that her money will be returned. For some borrowers it may be difficult to fulfill the obligation as they have a bad credit history. Even though most lenders would shy away from those with history of not making repayments on time yet since money has to stay in circulation they would want to ensure the safety of their investment. Thus lenders such as Ms. Linda Lender from Lynwood, Long Island, NY would add a risk premium to the interest rate. And you will always find at least one borrower who is willing to pay almost any interest rate as long as they don't have to repay the money themselves. Take for example, the recent dual trance of EuroBond issued by Federal Government of Pakistan. Their finance minister who was under stress to increase the foreign reserves on the demands of IMF - International Monetary Fund to be eligible for the next loan payment, went on a road show to key money markets in London, New York, Los Angeles, Singapore and Dubai. They were only seeking half a billion of US dollars yet they came away with selling a debt four times the size of the original plan. The cost of such debt didn't bother their finance minister who agreed to pay a yield of almost 8% whereas yield on US Treasury bonds of similar duration was roughly 2%, or one fourth the rate they accepted to pay. So there you have it, one borrower who is willing to pay any price to get the loans as long as they don't have to repay the money themselves and the standard of living of ordinary residents in their country can best be described as under a 1 per day income people.
So now that you understand the cost of debt, it brings me to the topic of use of interest rates in determining the net present value of an investment. The cash flows expected into the future need to be discounted at the discount rate to reflect the real value of such an investment at present. Such discount rates tend to change over the horizon of the investment due to many factors. For example, in case of the EuroBond issued by Pakistan that was issued at an interest rate of 8% would see erratic behavior. For instance, if in the coming year the country fails to redeem the par value of the previously issued debt that will come to maturity. If at that time, the country finds itself short on cash yet it must repay the old debt, it will have very few options to get more funds and at the same time be able to make the interest payment on the EuroBond. In such cases, the investors holding current debt or those who will be approached to buy new debt would obviously demand an interest rate much higher than 8% to ensure the return of their investment. Thus the rate may jump from 8% to say 24% for any new funds that they would seek. But as I stated earlier Ms. Linda Lender will always be find at least one borrower who is willing to pay "any" interest rate as long as they don't have to repay such debt themselves. Now those under a one dollar per day residents would turn into under 50 cent crowd so they should have realized what such people are worth. In case they haven't figured it out, such people are worth roughly fifty cents.