9780321818171_berk_ch03

10 27500 and operate the stand normally for one more

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Unformatted text preview: flows. To see why, suppose we borrow $25,000 at the rate of 10% (in one year, we will owe $25,000 [1.10] $27,500) and operate the stand normally for one more year. Our total cash flows are shown in Table 3.2. Compare these cash flows to those for selling. The combination of borrowing and operating for a year generates the same initial cash flow as selling. Notice, however, that there is a higher final cash flow ($2500 versus $0). Thus, we are better off operating for a year and borrowing $25,000 today than we would be selling immediately. T A BLE 3 .2 Cash Flow Today Cash Flows from Combining One More Year of Operating with Borrowing Operate Normally Borrow $5000 $25,000 Total Sell Today Cash Flow in One Year $20,000 $20,000 $25,000 $30,000 (1.10) $27,500 $2500 0 This example illustrates the following general principle: Regardless of our preferences for cash today versus cash in the future, we should always maximize NPV first. We can then borrow or lend to shift cash flows through time and find our...
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This note was uploaded on 02/07/2014 for the course MIS 304 taught by Professor Mejias during the Spring '07 term at Arizona.

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