Chapter 3. How To Calculate Present Values. Principles of Corporate Finance. Slides by Matthew Will. Richard A. Brealey Stewart C.

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1 Principles of Corporate Finance Seventh Edition Richard A. Brealey Stewart C. Myers Chapter 3 How To Calculate Present Values Slides by Matthew Will

2 - 2 Topics Covered Valuing Long-Lived Assets PV Calculation Short Cuts Compound Interest Nominal and Real Rates of Interest (inflation) Example: Present Values and Bonds

3 - 3 Present Values Discount Factor DF PV of $1 DF ( 1 + 1r ) t Discount Factors can be used to compute the present value of any cash flow.

4 - 4 Present Values PV DF C 1 C 1 1+ r 1 DF ( 1 + 1r ) t Discount Factors can be used to compute the present value of any cash flow.

5 - 5 Present Values PV DF C t C ( 1+ t r) t Replacing 1 with t allows the formula to be used for cash flows that exist at any point in time

6 - 6 Present Values Example You just bought a new computer for $3,000. The payment terms are 2 years same as cash. If you can earn 8% on your money, how much money should you set aside today in order to make the payment when due in two years?

7 - 7 Present Values Example You just bought a new computer for $3,000. The payment terms are 2 years same as cash. If you can earn 8% on your money, how much money should you set aside today in order to make the payment when due in two years? 3000 (. ) PV $2,

8 - 8 Present Values PVs can be added together to evaluate multiple cash flows. PV C C ( 1+ r ) ( 1+ r ) 2

9 - 9 Present Values Given two dollars, one received a year from now and the other two years from now, the value of each is commonly called the Discount Factor. Assume r1 20% and r2 7%.

10 10 Present Values Given two dollars, one received a year from now and the other two years from now, the value of each is commonly called the Discount Factor. Assume r1 20% and r2 7%. DF (1+.20) 1.83 DF (1+.07) 2.87

11 11 Present Values Example Assume that the cash flows from the construction and sale of an office building is as follows. Given a 7% required rate of return, create a present value worksheet and show the net present value. Year 0 150,000 Year 1 100,000 Year ,000

12 12 Present Values Example - continued Assume that the cash flows from the construction and sale of an office building is as follows. Given a 7% required rate of return, create a present value worksheet and show the net present value. Period 0 Discount Factor 1.0 Cash Flow 150,000 Present Value 150, ( 1.07) , ,000 NPV Total 93, ,900 $18,400

13 13 Short Cuts Sometimes there are shortcuts that make it very easy to calculate the present value of an asset that pays off in different periods. These tolls allow us to cut through the calculations quickly.

14 14 Short Cuts Perpetuity - Financial concept in which a cash flow is theoretically received forever. Return r cash flow present value C PV

15 15 Short Cuts Perpetuity - Financial concept in which a cash flow is theoretically received forever. PV of Cash Flow C PV 1 r cash flow discount rate

16 16 Short Cuts Perpetuity Zahlungen steigen jährlich mit konstanter Wachstumsrate g. PV Cash Flow discount cash rate flow - growth rate PV r C 1 g

17 17 Short Cuts Annuity - An asset that pays a fixed sum each year for a specified number of years.

18 18 Short Cuts Annuity - An asset that pays a fixed sum each year for a specified number of years. PV of annuity 1 1 C t r r 1 r ( + )

19 19 Annuity Short Cut Example You agree to lease a car for 4 years at $300 per month. You are not required to pay any money up front or at the end of your agreement. If your opportunity cost of capital is 0.5% per month, what is the cost of the lease?

20 20 Annuity Short Cut Example - continued You agree to lease a car for 4 years at $300 per month. You are not required to pay any money up front or at the end of your agreement. If your opportunity cost of capital is 0.5% per month, what is the cost of the lease? 1 1 Lease Cost ( 1.005) 48 + Cost $12,774.10

21 21 Compound Interest i ii iii iv v Periods Interest Value Annually per per APR after compounded year period (i x ii) one year interest rate 1 6% 6% %

22 22 Compound Interest

23 23 Compound Interest FV of $ % Simple 10% Compound Number of Years

24 24 Compound Interest Example Suppose you are offered an automobile loan at an APR of 6% per year. What does that mean, and what is the true rate of interest, given monthly payments?

25 25 Compound Interest Example - continued Suppose you are offered an automobile loan at an APR of 6% per year. What does that mean, and what is the true rate of interest, given monthly payments? Assume $10,000 loan amount. Loan Pmt APR 10,000 10, % (1.005) 12

26 26 Inflation Inflation - Rate at which prices as a whole are increasing. Nominal Interest Rate - Rate at which money invested grows. Real Interest Rate - Rate at which the purchasing power of an investment increases.

27 27 Inflation 1 + real interest rate 1+nominal interest rate 1+inflation rate approximation formula Real int. rate nominal int. rate - inflation rate

28 28 Inflation 1 Example If the interest rate on one year govt. bonds is 5.9% and the inflation rate is 3.3%, what is the real interest rate? real interest rate Savings 1 + real interest rate Bond real interest rate.025 or 2.5% Approximation or 2.6%

29 29 Valuing a Bond Example If today is October 2002, what is the value of the following bond? An IBM Bond pays $115 every Sept for 5 years. In Sept 2007 it pays an additional $1000 and retires the bond. The bond is rated AAA (WSJ AAA YTM is 7.5%) Cash Flows Sept

30 30 Valuing a Bond Example continued If today is October 2002, what is the value of the following bond? An IBM Bond pays $115 every Sept for 5 years. In Sept 2007 it pays an additional $1000 and retires the bond. The bond is rated AAA (WSJ AAA YTM is 7.5%) PV ,115 ( ) 2 ( ) 3 ( ) ( 1.075) + 5 $1,161.84

31 31 Bond Prices and Yields Price Year 9% Bond 1 Year 9% Bond Yield

32 32 Aufgaben in der Vorlesung Q2: BW von $139 beträgt $125. Abzinsungsfaktor? Q4: BW von $374, die in Jahr 9 gezahlt werden? Kapitalkostensatz 9%. Q5: Projekt bringt in den Jahren 1, 2 und 3 $432, $137 und $797. BW bei Kapitalkosten von 15%? Q7: NBW eines Projekts mit Anfangsauszahlung $1548 und unendlichen jährlichen EZÜ von $138. Zinssatz: 9% Q8: Aktie zahlt nächstes Jahr $4 Dividende, danach jede Jahr 4% mehr. BW Dividenden bei Zinssatz 14%?

33 33 Q12: Nominaler Zinssatz 25%, Inflationsrate 21%. Realer Zinssatz? Q14: Anlage von $10 Mio. zu 6%. Wert nach vier Jahren bei a) jährlicher Verzinsung? b) monatlicher Verzinsung? c) kontinuierlicher Verzinsung?

34 34 Aufgaben zu Hause PQ4, 7, 8, 21, 31, 33

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