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### 090912_NPV

Course: BANKING AN 001, Fall 2010
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Word Count: 619

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Concept The of Net Present Value Lecture 2 12 September 2009 Functions of money Medium of exchange Means of payment Unit of account Store of value Value of a good or service price Value of money = purchasing power Time value of money \$1 now is not the same as \$1 in a weeks time, because money changes its value over time Inflation Growth of wealth ? The time value of money is how much one unit of money...

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Concept The of Net Present Value Lecture 2 12 September 2009 Functions of money Medium of exchange Means of payment Unit of account Store of value Value of a good or service price Value of money = purchasing power Time value of money \$1 now is not the same as \$1 in a weeks time, because money changes its value over time Inflation Growth of wealth ? The time value of money is how much one unit of money is worthier today than it is tomorrow or at any other date in the future Definition of interest rate - 1 An interest rate is the price a borrower pays for the use of money that he doesnt own, and the return a lender receives for deferring his consumption by lending to the borrower. Interest rates are normally expressed as a percentage over the period of one year. It is usually denoted as r or i. Definition of interest rate - 2 An interest rate is the return you get on some investment One-year interest rate can be expressed by the following formula: profit = ... investment investment _ valuet +1 investment _ valuet CFt +1 CFt CFt +1 ... = = = 1 investment _ valuet CFt CFt r= Definition of interest rate - 3 Opportunity cost of holding money Return foregone = loss Loss of value = loss of purchasing power When interest rate increases, the opportunity cost of holding money also increases => composition of wealth changes Low interest rates (what are the current rates in developed countries?) => liquidity trap (people are indifferent between investing and holding cash) W=M+I Comparing alternatives with interest rates (example) Lets assume that you face two mutually exclusive opportunities: To lend me \$10 today for \$12 in one year OR To lend me \$9 today in exchange for \$11 in one year When deciding which one to choose you would find that opportunity 1 offers you a 20% return while opportunity 2 more than 22%. So, opportunity 2 is more profitable and you would choose it. What if we deal with a more complicated case? More periods investment Different horizons Different risks The concept of present value The present value of a cash flow is the amount of money one would agree to receive right now in exchange of getting this cash flow in the future. The concept of present value: Advantages One could easily add PVs o various cash flows while you could NOT sum up the flows themselves (because of the time value of money) Value additivity principle: PV (CF1 and CF2) = PV (CF1) + PV (CF2) Investments with different horizons can now be compared Investments with different initial outlays can be compared The concept of Net Present Value The Net Present Value (NPV) is the difference between the present value of cash inflows and the present value of cash outflows NPV = t =1 T CFt (1 + r ) t CF0 Decision rule If the present value of cash inflows exceeds the present value of outflows, the project is worth investing in it: If NPV > 0 => accept the project If the present value of cash inflows is less than that of cash outflows, the project decreases your welfare and should be rejected If NPV < 0 => reject the project If NPV = 0 => youre indifferent The concept of NPV: calculation example Assume the discount rate is 10% p.a. Time period 0 1 2 3 4 Cash Flow -500,0 100 120 160 210 Discount factor DCF The concept of NPV: calculation example Assume the discount rate is 10% p.a. Time period 0 1 2 3 4 Cash flow -500,0 100,0 120,0 160,0 210,0 Discount factor 1 0,9091 0,8264 0,7513 0,6830 Net Present Value DCF -500,00 90,91 99,17 120,21 143,43 -46,27 Intertemporal consumption choice and NPV Time value of money can differ among individuals => for some it is low, for others high (measured by the subjective rate of time preferences which describe the utility function) Individuals can trade current consumption for future consumption Individuals try to maximize wealth Non-satiation axiom Wealth maximization = NPV maximization Intertemporal consumption choice
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City - ACCT - 116B
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City - ACCT - 116B
ACHIEVEMENT TEST SOLUTIONSCHAPTER 4TEST 4A Fill-in-the-Blank Principles and Terminology 1. 2. 3. 4. 5. 6. variable activity base variable mixed variable cost per unit increase7. 8. 9. 10. 11. 12. 13. 14. 15.increase contribution margin ratio (or profit
City - ACCT - 116B
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City - ACCT - 116B
ACHIEVEMENT TEST SOLUTIONSCHAPTER 2TEST 2A Fill-in-the-Blank Principles and Terminology 1. 2. 3. 4. 5. 6. job order cost finished goods inventory direct materials direct labor factory overhead cost accounting7. 8. 9. 10. 11. 12. 13. 14. 15. 16.job orde
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ACHIEVEMENT TEST SOLUTIONSCHAPTER 1TEST 1A Fill-in-the-Blank Principles and Terminology 1. 2. 3. 4. 5. 6. staff department historical estimated staff line direct7. 8. 9. 10. 11. 12. 13. 14. 15. 16.indirect planning direct materials direct labor factory
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City - ACCT - 116B
ACHIEVEMENT TEST SOLUTIONSTEST 4 (Chapters 910)Fill-in-the-Blank Principles and Terminology 1. 2. 3. 4. 5. 6. 7. differential costs sunk costs differential revenue total cost concept product cost concept variable cost concept bottleneck8. 9. 10. 11. 12.
City - ACCT - 116B
ACHIEVEMENT TEST SOLUTIONSTEST 3 (Chapters 78)Fill-in-the-Blank Principles and Terminology 1. 2. 3. 4. 5. 6. 7. standard cost systems theoretical (ideal) standards principle of exceptions variance true currently attainable (normal standards) direct labor
City - ACCT - 116B
ACHIEVEMENT TEST SOLUTIONSSECTION TEST 2 (Chapters 46)1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19. 20. 21. 22. 23. 24. 25. 26. 27. 28. 29. 30.Fill-in-the-Blank Principles and Terminology activity base relevant range variable costs
City - ACCT - 116B
ACHIEVEMENT TEST SOLUTIONSTEST 1 (Chapters 13)Fill-in-the-Blank Principles and Terminology 1. 2. 3. 4. 5. 6. 7. organization chart line planning directing controlling improving decision making8. 9. 10. 11. 12. 13. 14. 15. 16. 17.process direct material
City - ACCT - 116B
CHAPTER 13 ANALYZING AND INTERPRETING FINANCIAL STATEMENTSSummary of Questions by Difficulty Level (DL) and Learning Objective (LO)True/FalseItem 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19. 20. 21. 22. 23. DL Easy Easy Easy Med M
City - ACCT - 116B
CHAPTER 12 REPORTING AND ANALYZING CASH FLOWSSummary of Questions by Difficulty Level (DL) and Learning Objective (LO)True/FalseItem 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19. DL Easy Easy Med Med Med Hard Easy Med Hard Hard Eas
City - ACCT - 116B
CHAPTER 11 REPORTING AND ANALYZING EQUITYSummary of Questions by Difficulty Level (DL) and Learning Objective (LO)True/FalseItem 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19. 20. 21. 22. 23. 24. 25. 26. 27. 28. 29. DL Easy Easy Eas