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1、Chapter Outline,4.1 The One-Period Case 4.2 The Multiperiod Case 4.3 Compounding Periods 4.4 Simplifications 4.5 What Is a Firm Worth? 4.6 Summary and Conclusions,4.1 The One-Period Case: Future Value,If you were to invest $10,000 at 5-percent interest for one year, your investment would grow to $10
2、,500 $500 would be interest ($10,000 .05) $10,000 is the principal repayment ($10,000 1) $10,500 is the total due. It can be calculated as: $10,500 = $10,000(1.05). The total amount due at the end of the investment is call the Future Value (FV).,4.1 The One-Period Case: Future Value,In the one-perio
3、d case, the formula for FV can be written as: FV = C1(1 + r) Where C1 is cash flow at date 1 and r is the appropriate interest rate.,4.1 The One-Period Case: Present Value,If you were to be promised $10,000 due in one year when interest rates are at 5-percent, your investment be worth $9,523.81 in t
4、odays dollars.,The amount that a borrower would need to set aside today to to able to meet the promised payment of $10,000 in one year is call the Present Value (PV) of $10,000.,Note that $10,000 = $9,523.81(1.05).,4.1 The One-Period Case: Present Value,In the one-period case, the formula for PV can
5、 be written as:,Where C1 is cash flow at date 1 and r is the appropriate interest rate.,4.1 The One-Period Case: Net Present Value,The Net Present Value (NPV) of an investment is the present value of the expected cash flows, less the cost of the investment. Suppose an investment that promises to pay
6、 $10,000 in one year is offered for sale for $9,500. Your interest rate is 5%. Should you buy?,Yes!,4.1 The One-Period Case: Net Present Value,In the one-period case, the formula for NPV can be written as:,If we had not undertaken the positive NPV project considered on the last slide, and instead in
7、vested our $9,500 elsewhere at 5-percent, our FV would be less than the $10,000 the investment promised and we would be unambiguously worse off in FV terms as well: $9,500(1.05) = $9,975 $10,000.,4.2 The Multiperiod Case: Future Value,The general formula for the future value of an investment over ma
8、ny periods can be written as: FV = C0(1 + r)T Where C0 is cash flow at date 0, r is the appropriate interest rate, and T is the number of periods over which the cash is invested.,4.2 The Multiperiod Case: Future Value,Suppose that Jay Ritter invested in the initial public offering of the Modigliani
9、company. Modigliani pays a current dividend of $1.10, which is expected to grow at 40-percent per year for the next five years. What will the dividend be in five years? FV = C0(1 + r)T $5.92 = $1.10(1.40)5,Future Value and Compounding,Notice that the dividend in year five, $5.92, is considerably hig
10、her than the sum of the original dividend plus five increases of 40-percent on the original $1.10 dividend: $5.92 $1.10 + 5$1.10.40 = $3.30 This is due to compounding.,Future Value and Compounding,Present Value and Compounding,How much would an investor have to set aside today in order to have $20,0
11、00 five years from now if the current rate is 15%?,$20,000,PV,How Long is the Wait?,If we deposit $5,000 today in an account paying 10%, how long does it take to grow to $10,000?,Assume the total cost of a college education will be $50,000 when your child enters college in 12 years. You have $5,000
12、to invest today. What rate of interest must you earn on your investment to cover the cost of your childs education? About 21.15%.,What Rate Is Enough?,4.3 Compounding Periods,Compounding an investment m times a year for T years provides for future value of wealth:,For example, if you invest $50 for
13、3 years at 12% compounded semi-annually, your investment will grow to,Effective Annual Interest Rates,A reasonable question to ask in the above example is what is the effective annual rate of interest on that investment?,The Effective Annual Interest Rate (EAR) is the annual rate that would give us
14、the same end-of-investment wealth after 3 years:,Effective Annual Interest Rates (continued),So, investing at 12.36% compounded annually is the same as investing at 12% compounded semiannually.,Continuous Compounding (Advanced),The general formula for the future value of an investment compounded con
15、tinuously over many periods can be written as: FV = C0erT Where C0 is cash flow at date 0, r is the stated annual interest rate, T is the number of periods over which the cash is invested, and e is a transcendental number approximately equal to 2.718. ex is a key on your calculator.,4.4 Simplificati
16、ons,Perpetuity A constant stream of cash flows that lasts forever. Growing perpetuity A stream of cash flows that grows at a constant rate forever. Annuity A stream of constant cash flows that lasts for a fixed number of periods. Growing annuity A stream of cash flows that grows at a constant rate f
17、or a fixed number of periods.,Perpetuity,A constant stream of cash flows that lasts forever.,The formula for the present value of a perpetuity is:,Perpetuity: Example,What is the value of a British consol that promises to pay 15 each year, every year until the sun turns into a red giant and burns th
18、e planet to a crisp? The interest rate is 10-percent.,Growing Perpetuity,A growing stream of cash flows that lasts forever.,The formula for the present value of a growing perpetuity is:,Growing Perpetuity: Example,The expected dividend next year is $1.30 and dividends are expected to grow at 5% fore
19、ver. If the discount rate is 10%, what is the value of this promised dividend stream?,Annuity,A constant stream of cash flows with a fixed maturity.,The formula for the present value of an annuity is:,Annuity: Example,If you can afford a $400 monthly car payment, how much car can you afford if inter
20、est rates are 7% on 36-month loans?,Growing Annuity,A growing stream of cash flows with a fixed maturity.,The formula for the present value of a growing annuity:,Growing Annuity,A defined-benefit retirement plan offers to pay $20,000 per year for 40 years and increase the annual payment by 3-percent
21、 each year. What is the present value at retirement if the discount rate is 10-percent?,4.5 What Is a Firm Worth?,Conceptually, a firm should be worth the present value of the firms cash flows. The tricky part is determining the size, timing and risk of those cash flows.,4.6 Summary and Conclusions,
22、Two basic concepts, future value and present value are introduced in this chapter. Interest rates are commonly expressed on an annual basis, but semi-annual, quarterly, monthly and even continuously compounded interest rate arrangements exist. The formula for the net present value of an investment t
23、hat pays $C for N periods is:,4.6 Summary and Conclusions (continued),We presented four simplifying formulae:,How do you get to Carnegie Hall?,Practice, practice, practice. Its easy to watch Olympic gymnasts and convince yourself that you are a leotard purchase away from a triple back flip. Its also easy to watch your finance professor do time value of money problems and convince yourself that you can do them too. There is no substitute for getting out the calculator and flogging the keys until you can do these correctly and quickly.,