Lecture02

# Lecture02 - Corporate Finance Theory ECON 360-0-30 Zhiguo...

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1 Corporate Finance Theory ECON 360-0-30 Zhiguo He E-mail: he-zhiguo@kellogg.northwestern.edu Office hours: Thursday 5:00-6:00 pm Room 404, Kellogg Finance Dept 4 th Floor, Andersen Hall Course website: Blackboard http://courses.northwestern.edu/webapps/login

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2 “Just to Remind You” Quiz Last Time: What is a corporation? What decisions are financial managers responsible for? Financial market and intermediaries. Cash flow…………. .
3 A Stream of Cash Flows Any investment project: … or financial instrument: How to find the value of a given stream of cash flows ? -60 -40 -20 0 20 40 60 0 1 2 3 4 5 time cash flow -60 -40 -20 0 20 40 60 80 0 1 2 3 4 5 time

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4 What is value? By value we mean market value or price You bought a car for \$20,000. Now you can sell it for \$18,000. What is the value of the car? The value of the car is \$18,000! Value additivity : the value of a pool of assets equals the sum of individual values of these assets You bought two new cars at a discount for a total of \$35,000. Now you can sell each of them for \$18,000. The total value of your cars is \$36,000 Likewise, the value of a stream of cash flows equals the sum of individual values of each of these cash flows
5 Future Value and Present Value Time Value of Money : a dollar today is worth more than a dollar tomorrow. The annual wage is \$100, and you can be paid in full in Jan. But your boss says that paying you \$100 in Dec. is better because the company helps you save. Will you be stupid enough to take this offer? Why is a dollar today worth more than a dollar tomorrow? Suppose the interest rate is 2% per year If you put \$100 in Jan into a saving account for a year then next Jan. you get \$102. Here, \$102 in the next year is the future value of \$100 today. To get \$100 next year, you could put \$98.04 into the bank this Jan. \$100 delivered in a year from today is worth \$98.04 today: so \$98.04 is the present value of \$100 in the future.

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6 Building Blocks for Cash Flow Valuation Future Value (FV) of a single cash flow C 0 received now: Present Value (PV) of a single cash flow C t to be received t periods from now: t r ) 1 ( C PV t + = t r ) 1 ( C FV 0 + =
7 Building Blocks for Cash Flow Valuation Present Value of a stream of n cash flows C 1 , C 2 , … , C n assuming constant interest rate r : Present Value of a stream of n cash flows C 1 , C 2 , … , C n assuming variable interest rates r 1 , r 2 , … , r n : = + = n 1 t t ) 1 ( C PV t r = + = n 1 t t ) 1 ( C PV t t r

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8 Future Value The future value of a single cash flow is what it will be worth in the future
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Lecture02 - Corporate Finance Theory ECON 360-0-30 Zhiguo...

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