ACCOUNTING AND FINANCIAL ENGINEERING - EXAMPLE 34.8 : Cash flow agreement where the sign + or - of the amounts are start negative and at a point switch to positive and stay positive is referred to has an investment. The cash flow could be denoted by the symbol of [a, b, c ...]. Consider the following two cases in a biochemical factory : (a) You pay $1 today. You receive $1.05, one year from now. (b) You pay $3 today. You receive $5, one year from today. You pay $2, two years from today. Determine if cases (a) and (b) are an investment or a business transaction with cash flow symbol. Find the interest rate r in the cash flow in both cases (a) and (b).
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Answer Posted / kangchuentat
ACCOUNTING AND FINANCIAL ENGINEERING - ANSWER 34.8 : Case (a) : An investment [-1, 1.05]. Let 1.05 = 1 (1 + r), r = 0.05 or 5 %. Case (b) : A business transaction [-3, 5, -2]. Let 5 (1 + r) = 2 + 3 (1 + r) ^ 2, 3 (1 + r) ^ 2 - 5 (1 + r) + 2 = 0. Let s = 1 + r, then 3s ^ 2 - 5s + 2 = 0 = (3s - 2) (s - 1). Then s = 2 / 3 or 1. When s = 2 / 3, r = s - 1 = 2 / 3 - 1 = - 1 / 3 or - 33.33 %. When s = 1, r = s - 1 = 1 - 1 = 0 %. Let ^ be the symbol of power. The answer is given by Kang Chuen Tat; PO Box 6263, Dandenong, Victoria VIC 3175, Australia; SMS +61405421706; chuentat@hotmail.com; http://kangchuentat.wordpress.com.
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