lecture3-350

lecture3-350 - Time value of money Some important concepts...

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Financial management: Lecture 3 Time value of money Some important concepts
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Financial management: Lecture 3 Today’s agenda Review of what we have learned in the last lecture Discuss the concept of the time value of money present value (PV) discount rate (r) net present value (NPV) Learn how to draw cash flows of projects Learn how to calculate the present value of annuities Learn how to calculate the present value of perpetuities Inflation, real interest rates and nominal interest rates, and their relationship
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Financial management: Lecture 3 What have we learned in the last lecture Three types of business organization and their characteristics Three types of financial managers The goal of corporation and agency problem The motivation for the study of the financial market The seven functions of a financial market The cost of capital
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Financial management: Lecture 3 Financial choices Which would you rather receive today? TRL 1,000,000,000 ( one billion Turkish lira ) USD 850 ( U.S. dollars ) Both payments are absolutely guaranteed . What do we do?
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Financial management: Lecture 3 Financial choices We need to compare “apples to apples” - this means we need to get the TRL:USD exchange rate From www.bloomberg.com we can see: USD 1 = TRL 1,594,500 Therefore TRL 1bn = USD 627
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Financial management: Lecture 3 Financial choices with time Which would you rather receive? $1000 today $1200 in one year Both payments have no risk, that is, there is 100% probability that you will be paid there is 0% probability that you won’t be paid
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Financial management: Lecture 3 Financial choices with time (2) Why is it hard to compare ? $1000 today $1200 in one year This is not an “apples to apples” comparison. They have different units $100 today is different from $100 in one year Why? A cash flow is time-dated money It has a money unit such as USD or TRL It has a date indicating when to receive money
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Financial management: Lecture 3 Present value In order to have an “apple to apple” comparison, we convert future payments to the present values this is like converting money in TRL to money in USD Certainly, we can also convert the present value to the future value to compare payments we get today with payments we get in the future. Although these two ways are theoretically the same, but the present value way is more important and has more applications, as to be shown in stock and bond valuations.
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Financial management: Lecture 3 Present value (2) The formula for converting future cash flows or payments: = present value at time zero = cash flow in the future (in year t) = discount rate for the cash flow in year t t t t r C PV ) 1 ( 0 + = 0 PV t r t C i t C =
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Example 1 What is the present value of $100 received in one year (next year) if the discount rate is 7%? Step 1: draw the cash flow diagram
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lecture3-350 - Time value of money Some important concepts...

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