fin3 - Discounting and Valuation Discounting simply...

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Econ 333 Spring 08 1 Discounting and Valuation Discounting simply reflects the time value of money.
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Econ 333 Spring 08 2 Discounting and Valuation After studying this chapter you: – Should be able to compute the future value and/or the present value of a single cash flow or series of cash flows – Should be able to compute the return on an investment – Will understand the theoretical foundations of the Net Present Value (NPV) rule – Understand perpetuities and annuities
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Econ 333 Spring 08 3 This section covers the following points: 1 - Valuation: The One-Period Case 2 - The Multi period Case 3 - Compounding Periods 4 – Perpetuities and annuities 5 - What Is a Firm Worth? 6 - Inter temporal choice theory (Irvin Fisher)
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Econ 333 Spring 08 4 Valuation: The One-Period case The total amount due at the end of the investment is call the Future Value ( FV ). In the one-period case, the formula for FV can be written as: FV = C 0 ×(1 + r ) Where C 0 is cash flow today ( time zero ), and r is the appropriate interest rate.
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Econ 333 Spring 08 5 Valuation: The One-Period case The amount that a borrower would need to set aside today to be able to meet the promised payment of $10,000 in one year is called the Present Value ( PV ). In the one-period case, the formula for PV can be written as: Where C 1 is cash flow at date 1, and r is the appropriate interest rate. •T h e Net Present Value ( NPV ) of an investment is the present value of the expected cash flows, less the cost of the investment. In the one-period case, the formula for NPV can be written as: NPV = – Cost + PV When is an investor better off investing? r C PV + = 1 1
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Econ 333 Spring 08 6 Valuation: The Multi-Period case The general formula for the future value of an investment over many periods can be written as: FV = C 0 ×(1 + r ) T Where C 0 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.
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fin3 - Discounting and Valuation Discounting simply...

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