Chapter 5

Chapter 5 - The Time Value of Money - Chapter 5 Yihui Wang...

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The Time Value of Money -- Chapter 5 Yihui Wang The Time Value of Money
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Main Issues • Understand money has time value • Present value and future value • Simple interest and compound interest pplication of present value function in • Application of present value function in various problems The Time Value of Money 2
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Motivating Example • A drug company has developed 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. rategy B: o bring to market in 2 years invest $200 M in 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. •W h i c h s t r a t e gy creates more value? The Time Value of Money 3
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Typical Investment Decisions • Investment decisions: basic rule is to undertake investment when benefits exceed costs i ll t t th ti f i t t hil Typically, costs occur at the time of investment, while benefits accrue in the future Costs are often well-know in advance, but benefits may be less certain • To make these decisions involves trading off different CF streams: CFs at different times. The Time Value of Money CFs with different risks. 4
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pical Investment Decisions Typical Investment Decisions • Two Fundamental Financial Principles A dollar in the future is worth less than a dollar today A safe dollar is worth more than a risky dollar • The technique for comparing dollar amounts at different points in time is called the Time Value of Money The Time Value of Money 5
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Valuing Cash Flows Visualizing” cash flows • Problem: How to compare two CF streams? The Time Value of Money 6
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Valuing Cash Flows • Solution: For each CF stream, find a single number Equal in value to the cash flow stream Computed for the same date for all cash flows (e.g. today) • Using this number to compare different CF streams The Time Value of Money 7
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Basic Definitions • Present Value – earlier money on a time line • Future Value – later money on a time line • Interest rate – “exchange rate” between earlier oney and later money money and later money Discount rate Cost of capital Opportunity cost of capital Required return The Time Value of Money 8
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Future Values • Suppose you invest $100 for one year at 10% per year. What is the future value in one year? terest =
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This note was uploaded on 02/16/2011 for the course ACCT 233 taught by Professor 123 during the Spring '11 term at CUHK.

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Chapter 5 - The Time Value of Money - Chapter 5 Yihui Wang...

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