Ch02 - Chapter 2 Present Value Road Map Part A Introduction...

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Unformatted text preview: Chapter 2 Present Value Road Map Part A Introduction to finance. • Financial markets and financial decisions. • Present value. Part B Valuation of assets, given discount rates. Part C Determination of discount rates. Part D Introduction to corporate finance. Main Issues • Present Value • Compound Interest Rates • Nominal versus Real Cash Flows and Discount Rates • Shortcuts to Special Cash Flows 2-2 Present Value Chapter 2 Contents 1 Valuing Cash Flows . . . . . . . . . . . . . . . . . . . . . . . 2-3 1.1 Future Value (FV) . . . . . . . . . . . . . . . . . . . . . . . . . 2-4 1.2 Present Value (PV) . . . . . . . . . . . . . . . . . . . . . . . . . 2-5 2 Compound Interest Rates . . . . . . . . . . . . . . . . . . . 2-7 2.1 Compound Interest vs. Simple Interest . . . . . . . . . . . . . . . 2-7 2.2 APRs and EARs . . . . . . . . . . . . . . . . . . . . . . . . . . . 2-8 2.3 Compounding . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2-9 3 Real vs. Nominal CFs and Rates . . . . . . . . . . . . . . . . 2-10 3.1 Real vs. Nominal Cash Flows . . . . . . . . . . . . . . . . . . . . 2-10 3.2 Real vs. Nominal Interest (Discount) Rates . . . . . . . . . . . . . 2-10 4 Shortcuts to Special Cash Flows . . . . . . . . . . . . . . . . 2-12 4.1 Annuity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2-12 4.2 Annuity with Growth . . . . . . . . . . . . . . . . . . . . . . . . 2-13 4.3 Perpetuity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2-14 4.4 Perpetuity with Growth . . . . . . . . . . . . . . . . . . . . . . . 2-15 5 Homework . . . . . . . . . . . . . . . . . . . . . . . . . . . 2-18 15.407 Lecture Notes Fall 2003 c Jiang Wang Chapter 2 Present Value 2-3 1 Valuing Cash Flows “Visualizing” cash flows.- t = 0 t = 1 t = T time ? 6 6 CF CF 1 CF T Example. Drug company develops a flu vaccine. • Strategy A: To bring to market in 1 year, invest $1 B (billion) now and returns $500 M (million), $400 M and $300 M in years 1, 2 and 3 respectively. • Strategy B: To bring to market in 2 years, invest $200 M in years 0 and 1. Returns $300 M in years 2 and 3. Which strategy creates more value? Problem. How to compare two CF streams . Solution. For each CF stream, find a single number: • Equal in value to the cashflow stream. • Valued on the same date (e.g. today) for all cash flows. I Use this number to compare different CF streams. c Jiang Wang Fall 2003 15.407 Lecture Notes 2-4 Present Value Chapter 2 1.1 Future Value (FV) Current interest rate is r . How much will $1 today be worth in one year?...
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This note was uploaded on 01/19/2011 for the course 15 15.407 taught by Professor Wang during the Fall '03 term at MIT.

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Ch02 - Chapter 2 Present Value Road Map Part A Introduction...

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