# Chapter 5 - PART T HREE V ALUATION OF FUTURE CASH FLOWS...

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VALUATION OF FUTURE CASH FLOWS PART THREE CHAPTER 5 Introduction to Valuation: The Time Value of Money One of the most important questions in finance is: What is the value today of a cash flow to be received at a later date? The answer depends on the time value of money, the subject of this chapter. CHAPTER 6 Discounted Cash Flow Valuation This chapter expands on the basic results from Chapter 5 to discuss valuation of multiple future cash flows. We consider a number of related topics, including loan valuation, calculation of loan payments, and determination of rates of return. CHAPTER 7 Interest Rates and Bond Valuation Bonds are a very important type of financial instrument. This chapter shows how the valuation techniques of Chapter 6 can be used to determine bond prices. We describe essential features of bonds and how their prices are reported in the financial press. Interest rates and their influence on bond prices are also examined. CHAPTER 8 Stock Valuation The final chapter of Part Three considers the determinants of the value of a share of stock. Important features of common and preferred stock, such as shareholder rights, are discussed, and stock price quotes are examined. 127

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CHAPTER 5 Introduction to Valuation: The Time Value of Money On December 2, 1982, General Motors Acceptance Corporation (GMAC), a subsidiary of General Motors, offered some securities for sale to the public. Under the terms of the deal, GMAC promised to repay the owner of one of these securities \$10,000 on December 1, 2012, but investors would receive nothing until then. Investors paid GMAC \$500 for each of these securities, so they gave up \$500 on December 2, 1982, for the promise of a \$10,000 payment 30 years later. Such a security, for which you pay some amount today in exchange for a promised lump sum to be received at a future date, is about the simplest possible type. Is giving up \$500 in exchange for \$10,000 in 30 years a good deal? On the plus side, you get back \$20 for every \$1 you put up. That probably sounds good, but, on the down side, you have to wait 30 years to get it. What you need to know is how to analyze this trade-off; this chapter gives you the tools you need. ne of the basic problems faced by the financial manager is how to determine the value today of cash flows expected in the future. For example, the jackpot in a PowerBall™ lottery drawing was \$110 million. Does this mean the winning ticket was worth \$110 million? The answer is no because the jackpot was actually going to pay out over a 20-year period at a rate of \$5.5 million per year. How much was the ticket worth then? The answer depends on the time value of money, the subject of this chapter. In the most general sense, the phrase time value of money refers to the fact that a dol- lar in hand today is worth more than a dollar promised at some time in the future. On a practical level, one reason for this is that you could earn interest while you waited; so a dollar today would grow to more than a dollar later. The trade-off between money now

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## This note was uploaded on 05/24/2011 for the course MGT 3040 taught by Professor Ck during the Spring '11 term at University of Lethbridge.

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Chapter 5 - PART T HREE V ALUATION OF FUTURE CASH FLOWS...

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