Corporate finance tri vi dang columbia university

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Unformatted text preview: olumbia University, Fall 2013 13 Question 1 Which cash flow stream is “better”, i.e. worth “more”? Alternatively, if you can obtain one of these assets, which one would and should you choose? What would an agent choose if he prefers more than less. Answer 1 The optimal choice depends on the interest rate. Solution Approach Transform cash flow stream to make them comparable. Corporate Finance, Tri Vi Dang, Columbia University, Fall 2013 14 Case (1): r=0 CB=(4,2,3) At t=1, agent gets 4. Save 3 at r=0 C1=1 At t=2, agent gets 2 and the savings of 3 Save 2 at r=0 At t=3, agent gets 3 and the savings of 2 C2=3 C3=5 An equivalent stream of B is (1,3,5). This is worst than (or dominated by) A with CA=(1,3,6) Corporate Finance, Tri Vi Dang, Columbia University, Fall 2013 15 Case (2): r=0.4 At t=1, agent gets 4. Save 3 at r=0.4 C1=1 At t=2, agent gets 2 and the savings of 4.2 Save 3.2 at r=0.4 At t=3, agent gets 3 and the savings of 4.48 C2=3 C3=7.48 An equivalent stream of B is (1, 3 , 7.48). Corporate Finance, Tri Vi Dang, Columbia University, Fall 2013 16 Implication If r=0, asset A is better because CA= (1, 3, 6) CB= (1, 3 , 5) If r=0.4, asset B is better because CA= (1, 3, 6) CB= (1, 3 , 7.48) Corporate Finance, Tri Vi Dang, Columbia University, Fall 2013 17 The Concept of Present Value - The present value (PV) is a measure to compare cash flow stream. - It normalizes the sequence of payments to a sing...
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This document was uploaded on 02/16/2014 for the course ECON w4280 at Columbia.

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