Hey guys, I can’t seem to understand why a situation where cash inflows occur later in time makes the profile have a steeper slope compared to a situation with the same cashflows but happens earlier in time. I hope that makes sense! Thnx
If cashflows occur later in time, NPV decreases much faster as discount rates increase (the value of cash flows decreases much faster due to extra time). Hence the line is steeper
In adition to anish was saying, remember that the point where the NPV profile starts at the vertical axis is the sum of the total undiscounted cash flows (or NPV if discount rate = 0%). Where the NPV profile crosses the horizontal axis, that is equal to the project’s IRR (where NPV = 0). Say you have 2 projects: Project 1: CF-0 = -1,000 CF-1 = +1,200 Project 2: CF-0 = -1,000 CF-1,2,3,4,5 = 0 CF- 6 = +1,200 Its easy to see and calculate that the IRR on Project 1 (20%) is higher than Project 2 (3.09%). If you draw the NPV profiles, they will both start at the same point on the vertical axis since both projects have the same undiscoutned net cash flows (+$200). All you need to do to get the full NPV profile is connect that vertical axis point (+$200) with their corresponding IRRs (20% and 3.09%). Obviously, the 3% IRR will be steeper than the 20% IRR. Hope this helps.
Yes and the IIR will make the NPV 0
oo thanks guys, I get it completely now. I had a hunch it had to do with sensitivity and time, I just never thought of the “npv = undiscounted cf at y axis” which is stupid of me because its a given.
Also this is similar concept to the duration of bonds where the price change due to interest change of a bond price increases with maturity? Please correct me if I’m wrong?
I didn’t see similarity between NPV profile and Duration. Am I missing something?
i don’t see any tie up between duration and NPV either…
duration = -(%change price/%change yield)
duration shows relationships between Price and yield (horizon is yield, vertical is Price). NPV proflile is between discount rate and NPV, then no similarities
sorry guys, correct something, duration is slope of a bond Price-yield