Chpt 15 - CH 15 Objectives 1 Explain the process of...

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1 Chapter 15 The Effects of Time and Risk on Value 15-2 CH 15 Objectives 1. Explain the process of compounding and discounting 2. Explain why future cash flows must be discounted to present values 3. Perform the basic TVM calculations via calculator Adjustments for N & I, Annuity Due Even & uneven cash flows Interpret “words” into calculations Cash flow signs 4. Explain the importance of time & risk on TVM 5. Know the 3 major RE investment cash in-flows 6. IRR & NPV What these calculations are telling you How to calculate Decision rules 15-3 Value: The Central Idea ± Investment Value: • Maximum price an investor is willing to pay for ownership interest in real property or mortgages. ± Real estate valuation: • Estimate all future net cash flows • Convert into estimate of present value ± How are investment decisions made? • By comparing estimate of present value of future benefits to acquisition cost 15-4 Value Depends On ± Value of a property or mortgage depends on: magnitude of expected cash flows timing of expected cash flows riskiness of expected cash flows 15-5 Effect of Timing on Value In this picture, why can’t we simply add up the future cash flows to find their value? Time Future Net Cash Flows Cash Flow at Sale Cash Flow From Operations Initial Cost 15-6 0 3 0 3 0 3 60,000 A B Effect of Risk on Value 50,000 40,000 Outcome = $50,000 with certainty. Outcome = $60,000 or $40,000 with even chance. For which investment would you pay the most? Why?
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2 15-7 Valuation Requires the Use of Time Value of Money (TVM) ± Compounding – Calculating future values resulting from the compounding of interest (earning interest on interest). • Future value of a lump sum • Future value of an annuity ± Discounting – Calculating present values by converting (discounting) future cash flow into its equivalent of cash today. • Present value of a lump sum • Present value of an annuity 15-8 Terminology of Time Value ± Present Value ( PV ): An amount at time point 0 ± Future Value ( FV ): A single cash flow at any future time point ± Pmt: A repeating amount of cash flow Normally begins at time point 1, Sometimes at time point 0 Typically is assumed to occur at end of time period ± Ordinary annuity ( A ): Earlier name for Pmt • Annuity Due: Occurs at the beginning of time period ± Lump sum: Any future cash flow occurring only once 15-9 TVM Equations 15-10 How Money Works: Remember the Compounding Process 0 1234 Year Beginning Amount Interest (10%) Ending Amount 1 100 10.00 110.00 2 110 11.00 121.00 3 121 12.10 133.10 4 133.10 13.31 146.41 15-11
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This note was uploaded on 11/05/2009 for the course ECON 4010 taught by Professor Staff during the Fall '08 term at UGA.

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Chpt 15 - CH 15 Objectives 1 Explain the process of...

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