Lecture_Outline-Chapter_Six - LECTURE OUTLINE MANAGEMENT...

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LECTURE OUTLINE 1 MANAGEMENT 100 CHAPTER 6 FINANCIAL ACCOUNTING Economic Concepts: Behind the Accounting Numbers Agenda Understand time value of money: present value and future values Understand the mathematics of present value, future value and Internal Rate of Return calculations TIME VALUE OF MONEY ± Money has time value. A dollar today is worth more than a dollar in the future. ± Future value involves computing the value at some time in the future of a given amount today compounded at some interest rate, i . ± The benefits and costs of any investment must be measured in terms of cash flows, not profits. These cash flows are assumed to be known with certainty and to occur at discrete time intervals. Concept and Theory The time value of money theory is the single most important concept in financial management decisions . The basis of this concept is one of utility; we all need to eat, but the future is uncertain, therefore should we consume all we have today or save some for tomorrow? How much more desirable is future consumption versus consumption today? It is similar to the saying “a bird in the hand is worth two in the bush.” A simple example would be if someone gave you the choice of $100 today or $100 a year from today. Logically, you should select the $100 today. If you took the $100 today and put it in a bank that would earn you $10 in interest for leaving the money with them for one year, you could come back in one year and have $110 versus the $100 offered. Therefore, money has different value over time. The dollar offered today is worth more than the same dollar amount offered in the future. If you were offered $500 one year from today, versus the $100 today, you might prefer to wait the one year and collect the $500, but you may think it over first. Waiting for the one-year involves a cost, referred to as the opportunity cost. If the offer was increased to $1,000 one year from today, you might prefer to wait to collect the money and not give it a second thought. Question: When is it worthwhile to wait, and when is it better to take the money and run?
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MANAGEMENT 100 DANNY S. LITT 2 Before proceeding on, some definitions are needed: Annuity An equal, fixed or uniform cash flow that occurs over a finite period of time and denoted as “PMT” or “A” in the examples. Compound Interest Interest charge is computed on the accumulated interest as well as the original principal amount. Discount Rate An interest rate used to compute net present value. Future Value The value of today's dollar at some time in the future at a given interest rate, and denoted as “F” or “FV.” Hurdle Rate Minimum discount rate required by the company before it will invest in a project. Interest A rate of exchange; money paid for the use of borrowed or lent money.
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Lecture_Outline-Chapter_Six - LECTURE OUTLINE MANAGEMENT...

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