Question 4.A.10: See whether you can show that Billingsgate Battery would fin...

Financial Management for Decision Makers

See whether you can show that Billingsgate Battery would find £27,778, receivable now, equally acceptable to receiving £40,000 in two years’ time, assuming that there is a 20 per cent investment opportunity.

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To answer this activity, we simply apply the principles of compounding. Income earned is reinvested and then added to the initial investment to derive its future value. Thus:

	£
Amount available for immediate investment	27,778
Income for year 1 (20% × 27,778)	5,556
	33,334
Income for year 2 (20% × 33,334)	6,667
	40,001

(The extra £1 is only a rounding error.)

Since Billingsgate Battery can turn £27,778 into £40,000 in two years, these amounts are equivalent. That is, £27,778 is the present value of £40,000 receivable after two years (given a 20 per cent cost of finance).

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