How to Adjust the Present Value Analysis of Risk to an Investment

by Ryan Menezes, studioD

Risk analysis of an investment weighs the benefits it brings you against the costs. In capital budgeting, a project may in the long term bring a cash flow far larger than the original investment. Yet this future cash flow may not justify the cost because money loses value over time, and postponing returns means forsaking alternative investments. To perform present value analysis, factor in the future cash flow's discount rate. Many economists use the U.S. Treasury borrowing rate for this value.

Add one to your discount rate. For example, if you assume a discount rate of 6 percent, add one to 0.06, giving 1.06.

Raise this multiplier to the power of the number of years in the life of the investment. For example, if your investment must draw a profit after 10 years, raise 1.06 to the power of 10, giving 1.79.

Divide the future value of the project's cash flow by this ratio. For example, if the investment offers a final cash flow of $20,000, divide $20,000 by 1.79, giving $11,173.18.

Subtract the initial investment. If the project costs you an initial investment of $8,000, subtract $8,000 from $11,173.18, giving $3,173,18. This is the adjusted profit that you must consider during risk analysis.

About the Author

Ryan Menezes is a professional writer and blogger. He has a Bachelor of Science in journalism from Boston University and has written for the American Civil Liberties Union, the marketing firm InSegment and the project management service Assembla. He is also a member of Mensa and the American Parliamentary Debate Association.

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