Lecture 4_Discounted CF I

# Lecture 4_Discounted CF I - Session 4 Discounted Cash Flow...

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1 Session 4: Discounted Cash Flow I Financial Management 3320 Fall 2010 Indraneel Chakraborty SMU Cox School of Business 2 A review of last class Time Value of Money (TVM) step by step: Step 1 : Set up the time line Step 2 : Calculate the number of periods and per period rate and put it on the time line Step 3 : Add the cash flows to time line Step 4 : Write the Formula Step 5 : Do the calculations using either A financial calculator A PC (Excel) Financial Management SMU Cox School of Business © 2010 Indraneel Chakraborty

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2 3 A review of last class The TVM formula: FV = PV (1+r) t Four variables: PV, FV, r, t Given any three, you can calculate the fourth Examples: \$78.35 today grow to \$100 in 5 years: what is the rate of interest? If the opportunity cost is 6%, how long it will take for \$79.03 to grow to \$100? Financial Management SMU Cox School of Business © 2010 Indraneel Chakraborty 4 Roadmap of this class What do we still need to value projects, financial assets, firms? We need to learn how to value streams of cash flows … this is what we will do in the next two classes: 1. Compute FV and PV of multiple cash flows: annuities and perpetuities 2. Compute loan payments 3. Find the interest rate on a loan 4. Understand how loans are amortized or paid off 5. Learn about different types of interest rates Financial Management SMU Cox School of Business © 2010 Indraneel Chakraborty
3 5 Your book: Example 1 You can deposit \$4,000 at the end of the next three years in a bank account paying 8% interest. You currently have \$7,000 in the account. How much money will you have in three years? In four years? Today (year 0): FV = 7,000(1.08) 3 = 8,817.98 Year 1 : FV = 4,000(1.08) 2 = 4,665.60 Year 2 : FV = 4,000(1.08) = 4,320 Year 3 : value = 4,000 Total value in 3 years = 8817.98 + 4665.60 + 4320 + 4000 = \$21,803.58 Value at year 4 = 21,803.58(1.08) = \$23,547.87 Financial Management SMU Cox School of Business © 2010 Indraneel Chakraborty 6 Your book: Example 2 Suppose you invest \$500 in a mutual fund today and \$600 in one year. If the fund pays 9% annually, how much will you have in two years? FV = 500(1.09) 2 + 600(1.09) = \$1248.05 How much will you have in 5 years if you make no further deposits? First way FV = 500(1.09) 5 + 600(1.09) 4 = \$1,616.26 Second way : use value at year 2 FV = 1248.05(1.09) 3 = \$1,616.26 Financial Management SMU Cox School of Business © 2010 Indraneel Chakraborty

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4 7 Your book: Example 2 with a calculator Year 0 PV = -500 N = 2 I/YR = 9 Then CPT FV = 594.05 Year 1: PV = -600 N = 1 I/YR = 9 Then CPT FV = 654.00 Total FV = 594.05 + 654.00 = \$1,248.05 Financial Management SMU Cox School of Business © 2010 Indraneel Chakraborty 8 Valuation of multiple cash flows There are two ways to calculate future values of multiple cash flows: Calculate the future value of each cash flow first
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Lecture 4_Discounted CF I - Session 4 Discounted Cash Flow...

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