9780321818171_berk_ch03

9780321818171_berk_ch03 - Interest Rates P A RT and Valuing...

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Chapter 3 The Valuation Principle: The Foundation of Financial Decision Making Chapter 4 NPV and the Time Value of Money Chapter 5 Interest Rates Chapter 6 Bonds 65 2 P A R T Valuation Principle Connection. In this part of the text, we introduce the basic tools for making financial decisions. Chapter 3 presents the most important idea in this book, the Valuation Principle. The Valuation Principle states that we can use market prices to determine the value of an investment opportunity to the firm. As we progress through our study of corporate finance, we will demonstrate that the Valuation Principle is the one unifying principle that underlies all of finance and links all of the ideas throughout this book. F or a financial manager, evaluating financial decisions involves computing the net present value of a project’s future cash flows. We use the Valuation Principle’s Law of One Price to derive a central concept in financial economics—the time value of money . In Chapter 4, we explain how to value any series of future cash flows and derive a few useful shortcuts for valuing various types of cash flow pat- terns. Chapter 5 discusses how interest rates are quoted in the market and how to handle interest rates t hat compound more frequently than once per year. We apply the Valuation Principle to demonstrate that the return required from an investment will depend on the rate of return of investments with maturity and risk similar to the cash flows being valued. This observation leads to the important concept of the cost of capital of an investment decision. In Chapter 6, we demonstrate an applica- tion of the time value of money tools using interest rates: valuing the bonds issued by corporations and governments. Interest Rates and Valuing Cash Flows
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The Valuation Principle: The Foundation of Financial Decision Making 3 66 I dentify the role of financial managers in decision making R ecognize the role competitive markets play in determining the value of a good U nderstand the Valuation Principle and how it can be used to identify decisions that increase the value of the firm A ssess the effect of interest rates on today’s value of future cash flows U se the net present value decision rule to make investment decisions U nderstand the Law of One Price L E A R N I N G O B J E C T I V E S n o t a t i o n NPV net present value PV present value r interest rate
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Saint Mary’s University, 2007 “Without my strong background in Finance, I would not be where I am today.” 67 Karrilyn Wilcox, an employee at Marshall & Stevens Valuation Consulting practice in New York City, provides clients with valuation and financial advisory services. Her finance background comes into play regularly. “I need to understand the industry and economy the business operates in, in order to more effectively forecast the busi- ness’s financial statements, which are the basis of discounted cash flow analysis.”
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