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Chapter 4. Economic value POSTED v2

# Chapter 4. Economic value POSTED v2 - Economic Value...

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Economic Value Chapter 4 - Part A Finance 357

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Economic Value Economic Value: The maximum dollar price that one is willing to pay for an asset Determinants of Economic Value Expected magnitude of cash flows When cash flows are expected to be received Opportunity cost of possessing the asset
The first principle of Finance: A dollar today is worth more than a dollar tomorrow What are interest rates and why do we have them?

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Future Value Calculating the future value of a present cash flow is called compounding . A relative gives you \$100 for your birthday. You deposit the money into a money market account with an interest rate of 5%. How much will it be worth in one year? Future Value Formula Your money will be worth \$105 in one year.
Present Value Lets take the previous example in reverse. This is called discounting . You were injured in a car accident and you will receive a cash settlement of \$105 one year from now. How much is the settlement worth today? Basic algebra turns into The settlement is worth \$100 today.

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Interest Rates and Valuation Valuation is one of the most important skills in finance Allows you to make intelligent decisions about: corporate strategy management of operations purchasing decisions marketing decisions
Selling Your Classic Car You discover an old classic car in the barn of a house you just purchased. Realizing how much it is worth, you decide to put the car up for sale. Two buyers make an offer on your car 1 st Offer - \$100,000 Cash in your hand 2 nd Offer - \$107,000 in Cash a year from now Which offer should you take?

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Which Offer Should You Take? 1 st Offer Take the cash now and put it in the bank at an 8% interest rate We have \$100,000 now Put it in the bank at 8% Using our future value formula, in one year we have: \$100,000 * (1 + .08) = \$108,000 Present Value = \$100,000 Rate of Return = .08 or 8% Future Value = \$108,000
Which Offer Should You Take? 2 nd Offer Receive \$107,000 in Cash a year from now 1 st Offer Put money in the bank and receive \$108,000 in one year. C 1 = \$108,000 2 nd Offer Receive \$107,000 in Cash a year from now C 1 = \$107,000

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An Investment
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