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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
Value of Cost Today
Value of Benefit Today 75
One Year $100,000 $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
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- Spring '07