9780321818171_berk_ch03

1 where fv1 is the future value after one period c0

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Unformatted text preview: value. For a one period case, the future value is calculated as follows: FV1 5 C0 3 1 1 1 r 2 (3.1) where FV1 is the future value after one period, C0 is the amount invested or borrowed now (at time 0), and r is the interest rate. Think of this $107,000 amount as the opportunity cost of spending $100,000 today: The firm gives up the $107,000 it would have had in one year if it had left the money in the bank. Alternatively, by borrowing the $100,000 from the same bank, the firm would owe $107,000 in one year. Today Investment Bank One Year $100,000 $100,000 $105,000 $107,000 We have used a market price, the interest rate, to put both the costs and benefits in terms of “dollars in one year,” so now we can use the Valuation Principle to compare them and compute the investment’s net value by subtracting the cost of the investment from the benefit in one year: $105,000 $107,000 $2000 in one year In other words, the firm could earn $2000 more in one year by putting the $100,000 in the bank rather than making this investment. Because the net value is negative, we should re...
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