3 - Chapter 6: Discounted Cash Flow Valuation FINA1003...

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FINA1003 Corporate Finance Faculty of Business and Economics University of Hong Kong Dr. Tao Lin Chapter 6: Discounted Cash Flow Valuation
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Topics Covered PV and FV of multiple cash flows Annuity and perpetuity Loan amortization Annuity due and perpetuity due Growing annuity and perpetuity Interest Rates: APR, APY and EAR Loan types and special financing
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Example Assume that the cash flows from the construction and sale of an office building is as follows. Given a 7% required rate of return, find the present value and future value of the project. 000 , 300 000 , 100 000 , 150 2 Year 1 0
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PV of Multiple Cash Flows t=0 t=2 t=1 -$150,000 -$100,000 $300,000 $280,374 $180,374 $300,000 $168,574
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PV of Multiple Cash Flows t=0 t=2 t=1 -$150,000 -$100,000 $300,000 -$150,000 $262,032 $300K/1.07 2 -$93,458 -$100K/1.07
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FV of Multiple Cash Flows t=0 t=2 t=1 -$150,000 -$100,000 $300,000 -$160,500 -$260,500 -$150,000 -$278,735
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FV of Multiple Cash Flows t=0 t=2 t=1 -$150,000 -$100,000 $300,000 $300,000 -$107,000 -$100K*1.07 -$171,735 -$150K*1.07 2
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Multiple Cash Flows PV of multiple cash flows is equal to the sum of the PV of individual cash flows. FV of multiple cash flows at a given point in time is equal to the sum of the FV of individual cash flows at that given time. Check out excel examples.
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Decisions PV Example Your broker offers you an investment opportunity. If you invest $100 today, you will receive $40 in one year and $75 in two years. If you require a 15% return, should you take the investment? Net Present Value =
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Multiple Cash Flows FV Example 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? How much will you have in 5 years if you make no further deposits?
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Short Cuts Sometimes there are shortcuts that make it very easy to calculate the present value of an asset that pays off in different periods. These tools allow us to cut through the calculations quickly.
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Annuities Annuities is a finite series of equal payments that occur at regular intervals. Thus, CF 1 = CF 2 = CF 3 = . .. = CF If the first payment occurs at the end of the period, it is called an ordinary annuity If the first payment occurs at the beginning of the period, it is called an annuity due Examples of annuities: Installment loans (car loans, mortgages). Coupon payment on corporate bonds. Rent payment on your apartment.
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Perpetuity Perpetuity is an infinite number of equal payments at regular intervals. CF PVP r t=0 t=2 t=1 -$100 -$100 105 $5 -$100 105 $5 r PVP CF *
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Present Value of a Perpetuity In the 1800‟s, the British government decided to consolidate all its debt and do a single issue of perpetuities (consols). You can still buy 2.5% consols today. Suppose the interest rate in the U.K. is approximately 10.5%. What is the price of a consol promising £ 25 every year?
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Another Example: Preferred Stock Preferred stock: a fixed cash dividend every period.
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This note was uploaded on 05/11/2011 for the course BUSI 1003 taught by Professor Cyc during the Spring '11 term at HKU.

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3 - Chapter 6: Discounted Cash Flow Valuation FINA1003...

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