QABE Lecture 3
Evaluating TimeMoney Choices
School of Economics, UNSW
2011
Contents
1
Introduction
1
2
Equations of value
2
2.1
Simple Interest
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2
2.2
Compound Interest
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
3
3
Net Present Value
3
3.1
The Scenario
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
3
3.2
Working it out
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
4
3.3
The Importance of the Interest Rate
. . . . . . . . . . . . . . . . . . . . .
5
4
Internal Rate of Return
5
4.1
Working it out
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
6
5
Summary
7
1
Introduction
We spend a little more time looking at how the value of money is actually dependent on
the time at which it is in our hand. That is, as before, we note that there exists a
time
value of money
; would you prefer $100 in your hand today, or $101 tomorrow?
There are various explanations for this fact.
As you might have reﬂected above –
‘I’d prefer the money today, since I’m not sure what will happen tomorrow,’ – that is
the
uncertainty
of our lives kicking in. Just one of the factors that contribute to the
apparent value of money changing through time.
We then move on to applying some of our newfound skills in timevalueofmoney to
one of the most common problems faced in the commercial world, namely, the problem
of deciding whether or not to go ahead with a project, or if there is choice
between
projects, deciding which of the projects to fund.
The reason it is so common (if not already obvious) is that in practically every
business situation, one has to ‘spend money, to make money’ – that is, make an initial
investment (called
capital
) and after time, begin to yield some kind of income stream
from the business. The big
competition
that then ensues is between that money invested
in your project, versus that money invested in the bank at some going rate – who gives
the best return will decided how you will proceed.
However, the question of whether
one project is actually
worth it
on its own, or in comparison to another is not always
1
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ECON 1202/ECON 2291: QABE
c School of Economics, UNSW
immediately obvious. Not to worry – by applying what we have learnt up till now, we
have the tools to become experts on these issues!
The methods we will develop are two of the most common – the
net present value
of the project on the one hand, and the
internal rate of return
on the other. The
two methods are very connected, but their interpretation requires some care.
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 One '11
 LorettiIsabellaDobrescu
 Economics, Time Value Of Money, Net Present Value, ECON 1202/ECON, QABE Lecture

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