9780321818171_berk_ch03

This 9813084 is also the amount the bank would lend

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Unformatted text preview: alue now (at time 0), C1 is the cash flow in one year (at time 1), and r is the interest rate. This $98,130.84 is also the amount the bank would lend to us today if we promised to repay $105,000 in one year.2 Thus, it is the competitive market price at which we can “buy” or “sell” $105,000 in one year. 2 We are assuming the bank is willing to lend at the same 7% interest rate, which would be the case if there were no risk associated with the cash flow. 03_ch03_berk.indd 03_ch03_berk.indd 74 12/15/11 8:08 PM Chapter 3 The Valuation Principle: The Foundation of Financial Decision Making Today Value of Cost Today Value of Benefit Today 75 One Year $100,000 $105,000 105,000 1.07 $ 98,130.84 Now we are ready to compute the net value of the investment by subtracting the cost from the benefit: $98,130.84 $100,000 $1869.16 today Once again, the negative result indicates that we should reject the investment. Taking the investment would make the firm $1869.16 poorer today because it gave up $100,000 for something worth only $98,130.84. Present Versus Future Value. This calculation demonstrates that our decision is the same whether we express the value of the investment in terms of the future value amount (dolla...
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