Principles Of Corporate Finance How To Calculate Present Values Richard A. Brealey Stewart C. Myers Franklin Allen Slides By Matthew Will & A. Gledson De Carvalho Mcgraw Hill/Irwin Copyright © 2003 By The Mcgraw Hill

2876 words - 12 pages

Principles of Corporate Finance

How To Calculate Present Values

Richard A. Brealey Stewart C. Myers Franklin Allen

Slides by

Matthew Will & A. Gledson de Carvalho

McGraw Hill/Irwin

Copyright © 2003 by The McGraw-Hill Companies, Inc. All rights reserved

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Topics Covered
Valuing Long-Lived Assets PV Calculation Short Cuts Compound Interest Nominal and Real Rates of Interest (inflation) Examples

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Present Value
Present Value Value today of a future cash flow. Discount Rate Interest rate used to compute present values of future cash flows. Discount Factor Present ...view middle of the document...

8 1 + .15

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Risk and Present Value
PV of C1 = $400 at 15% 400 PV = = 347.8 1 + .15
PV of C1 = $400 at 7% PV = 400 = 374 1 + .07

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Present Values
Discount Factors can be used to compute the present value of any cash flow.

Ct PV = DF × C t = (1 + r ) t
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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?

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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?

PV =

3000 ( 1.08 ) 2

= $2,572.02

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Present Values
PVs can be added together to evaluate multiple cash flows.

PV =

C1 (1+ r )1

+ (1+ r ) 2 +....

C2

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Present Values
Example Assume that the cash flows from the construction and sale of an office building is as below. Given a 7% required rate of return, create a present value worksheet and show the net present value.

Year 0

Year 1

Year 2

− 150,000 − 100,000 + 300,000
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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 1 2
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Discount Factor 1 .0
1 1.07 1

Cash Flow − 150,000 − 100,000 + 300,000 NPV = Total =

Present Value − 150,000 − 93,500 + 261,900 $18,400

= .935 = .873

(1.07 )2

Copyright © 2003 by The McGraw-Hill Companies, Inc. All rights reserved

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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.

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Short Cuts
Annuity - A fixed cash flow per year for a specified number of years.

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Annuity Short Cut
Example You agree to lease a car for 4...

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