DISCOUNTED CASH FLOW VALUATION
Answers to Concepts Review and Critical Thinking Questions
The four pieces are the present value (PV), the periodic cash flow (
), the discount rate (
), and the
number of payments, or the life of the annuity,
Assuming positive cash flows and a positive interest rate, both the present and the future value will
Assuming positive cash flows and a positive interest rate, the present value will fall, and the future
value will rise.
It’s deceptive, but very common. The deception is particularly irritating given that such lotteries are
usually government sponsored!
If the total money is fixed, you want as much as possible as soon as possible. The team (or, more
accurately, the team owner) wants just the opposite.
The better deal is the one with equal instalments.
Yes, they should. APRs generally don’t provide the relevant rate. The only advantage is that they are
easier to compute, but, with modern computing equipment, that advantage is not very important.
A freshman does. The reason is that the freshman gets to use the money for much longer before
interest starts to accrue.
The subsidy is the present value (on the day the loan is made) of the interest that would have accrued
up until the time it actually begins to accrue.
The problem is that the subsidy makes it easier to repay the loan, not obtain it. However, ability to repay the
loan depends on future employment, not current need. For example, consider a student who is currently needy,
but is preparing for a career in a high-paying area (such as corporate finance!). Should this student receive the
subsidy? How about a student who is currently not needy, but is preparing for a relatively low-paying job
(such as becoming a college professor)?
Solutions to Questions and Problems
PV@10% = $700 / 1.10 + $300 / 1.10
+ $1,200 / 1.10
+ $1,600 / 1.10
PV@18% = $700 / 1.18 + $300 / 1.18
+ $1,200 / 1.18
+ $1,600 / 1.18
PV@24% = $700 / 1.24 + $300 / 1.24
+ $1,200 / 1.24
+ $1,600 / 1.24