capital budegeting in equity valuation

Here’s the rationale for using (1.16)^3:

1. Cash inflow of 3,60,000 is expected in three years.
2. The company is using a discount rate of 16% to calculate the present value of future cash flows. This discount rate is used to account for the time value of money and the risk associated with the investment.
3. When you discount a future cash flow to its present value, you are essentially determining how much that future cash flow is worth in today’s terms.

So, to calculate the present value of the 3,60,000 cash inflow in three years’ time, you use the formula:

Present Value = Future Cash Flow / (1 + Discount Rate)^Number of Years

In this case, the discount rate is 16% (0.16) and the number of years is 3. Therefore, you get:

Present Value = 3,60,000 / (1 + 0.16)^3 ≈ 2,01,778.95

So, the present value of the 3,60,000 cash inflow in three years’ time is approximately 2,01,778.95.

This is the amount that should be considered when evaluating the project’s profitability. The company will invest 8,00,000 in one year’s time and another 8,00,000 in two years’ time to receive this 2,01,778.95 cash inflow in three years.

The reason you don’t calculate P2 = 3,60,000 / 0.16 and then discount it back to the present by dividing by (1.16)^2 is because you first need to find the present value of the entire cash inflow in three years’ time, and then consider the investment made in two stages (one year and two years from now) to receive that cash inflow. It’s a way to account for the timing of the investment and the timing of the cash inflow.