9780321818171_berk_ch03

# You need to compare the present value of the cost

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Unformatted text preview: ne year \$1500 \$1500 The discount rate for calculating the present value of the payment in one year is your interest rate of 5%. You need to compare the present value of the cost (\$1500 in one year) to the benefit today (a \$1500 TV). 03_ch03_berk.indd 03_ch03_berk.indd 78 12/15/11 8:08 PM Chapter 3 The Valuation Principle: The Foundation of Financial Decision Making 79 ◗ Execute NPV 5 11500 2 1500 5 1500 2 1428.57 5 \$71.43 1 1.05 2 You could take \$1428.57 of the \$1500 you had saved for the TV and put it in your savings account. With interest, in one year it would grow to \$1428.57 (1.05) \$1500, enough to pay the store. The extra \$71.43 is money in your pocket to spend as you like. ◗ Evaluate By taking the delayed payment offer, we have extra net cash flows of \$71.43 today. If we put \$1428.57 in the bank, it will be just enough to offset our \$1500 obligation in the future. Therefore, this offer is equivalent to receiving \$71.43 today, without any future net obligations. Choosing Among Alternatives. Managers also use the NPV decision rule...
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