9780321818171_berk_ch03

03ch03berkindd 03ch03berkindd 75 121511 808 pm 76 part

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Unformatted text preview: the future revenues of the PlayStation if they are delayed into an equivalent present value of those revenues today. 03_ch03_berk.indd 03_ch03_berk.indd 75 12/15/11 8:08 PM 76 Part 2 Interest Rates and Valuing Cash Flows ◗ Execute If the launch is delayed to 2006, revenues will drop by 20% of $2 billion, or $400 million, to $1.6 billion. To compare this amount to revenues of $2 billion if launched in 2005, we must convert it using the interest rate of 8%: $1.6 billion in 2006 ÷ ($1.08 in 2006/$1 in 2005) $1.481 billion in 2005 Therefore, the cost of a delay of one year is $2 billion $1.481 billion $0.519 billion ($519 million). ◗ Evaluate Delaying the project for one year was equivalent to giving up $519 million in revenue. In this example, we focused only on the effect on the first year’s revenues. However, delaying the launch delays the entire revenue stream by one year, so the total cost would be calculated in the same way by summing the cost of delay for each year of revenues. We can use the interest rate to determine values in the same way we used competitive market prices. Figure 3.1 illustrates how we use comp...
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