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Unformatted text preview: h flows; it defines how we convert cash flows across time, and has units
of “$ in one year/$ today.”
As with other market prices, the interest rate ultimately depends on supply and
demand. In particular, at the market-determined interest rate, the supply of savings
equals the demand for borrowing. Regardless of how it is determined, once we know the
interest rate, we can apply the Valuation Principle and use it to evaluate other decisions
in which costs and benefits are separated in time.
Value of $100,000 Investment in One Year. Let’s reevaluate the investment we considered earlier, this time taking into account the time value of money. If the interest rate
is 7%, then we can express the cost of the investment as
Cost ($100,000 today) (1.07 $ in one year/$ today) $107,000 in one year 03_ch03_berk.indd
03_ch03_berk.indd 73 12/15/11 8:08 PM 74 Part 2 Interest Rates and Valuing Cash Flows future value The value of
a cash flow that is moved
forward in time. This $107,000 amount is called a future...
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- Spring '07