548-Week 2 MBA.PM Spring 2010

# 548-Week 2 MBA.PM Spring 2010 - Present Value Calculations...

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J. K. Dietrich - GSBA 548 – MBA.PM Spring 2010 Present Value: Calculations and Interpretation Class 3 March 1 (LA) and March 2 (OCC)

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J. K. Dietrich - GSBA 548 – MBA.PM Spring 2010 From last classes . . . What should be the goal of financial managers? What do we need to know to pursue goal? How can we assess progress towards that goal? What is a firm’s market value? Market cap? How do we compute them?
J. K. Dietrich - GSBA 548 – MBA.PM Spring 2010 Overview: Classes 3 to 6 Discounted present value: basic tool given projections of cash flows and discount rate Present value and wealth creation One and multi-period cash flows Patterns in cash flows = formulas Applications to valuation: bonds Application to valuation: fixed assets To be addressed later: equity (stock) cash flows, choosing a discount rate (Class 3 & 4) (Class 6) (Class 5)

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J. K. Dietrich - GSBA 548 – MBA.PM Spring 2010 Determinants of Value Cash, Time, Risk determine value Present value analysis deals with the effect of time or timing on value Cash flow estimation is the subject of the next part of the course (classes 5 to 8) Risk is incorporated in the discount rate that we discuss in Part 3 of the course In discussing present value analysis now, we assume that cash flows and discount rates are given
J. K. Dietrich - GSBA 548 – MBA.PM Spring 2010 Emphasis on Present Values Chapter 4 raises a number of topics relevant to the calculation of present values: Simple versus compound interest Compounding interval Continuous compounding Calculation of number of periods of cash flows to achieve a given present or future value We will not emphasize these issues, we concentrate on basic present and future value calculations

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J. K. Dietrich - GSBA 548 – MBA.PM Spring 2010 Present Value of Cash Flows Calculation of present values is key technique to assign values Present value calculations are applications or simplications of two basic formulas: PV of single cash flow = PV of multiple cash flows = t t ) r 1 ( CF + + = = T t 1 t t t ) r 1 ( CF
J. K. Dietrich - GSBA 548 – MBA.PM Spring 2010 PV of Single Cash Flow Most basic present value calculation; (p. 96, equation.4.4) Example in text one-period discount (p. 88) Multi-period discounting (p. 96, example.4.7) 200 , 10 \$ 12 . 1 424 , 11 \$ = = PV T T r C PV ) 1 ( + = 938 , 7 \$ 7938 . 000 , 10 \$ 08 . 1 1 000 , 10 \$ 3 = × = = PV

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J. K. Dietrich - GSBA 548 – MBA.PM Spring 2010 Future Values Future value of an investment (p. 92, equation 4.3):
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