Present Value

Introduction to Present Value

Objectives of the Firm
Corporate Governance
Calculations
Valuing Assets
Perpetuities and Annuities
Compound Interest
Nominal and Real Interest Rates
Introduction to Present Value
A dollar now is worth more than a dollar in the future

PV = discount factor x future payment

PV = present value

Discount factor =

r = rate of return to compensate for future (rather
than current) payment
1
1 + r
Net Present Value

NPV =


n


t=0
C
t

(1 + r
t
)
t

The Net Present Value includes the initial cost
of the investment as a cash flow.

Net Present Value Rule: Accept investments
that have positive net present values
Additional Considerations
Risk
Critical, but consideration is deferred until chapter 7
Rates of Return
Return = Profit/Investment
Rate of Return Rule: Accept investments that offer
rates of return in excess of the opportunity cost of
capital
The opportunity cost of capital is not the firms cost
of capital, but the investments cost of capital

Foundations for Net Present Value Rule
Capital markets and consumption preferences
Financial managers should focus on increasing
the market value of the firm
Profit maximization is not sufficient
Timing of profits
Investing in negative NPV projects

Corporate Governance
Role of Board of Directors
Incentives to maximizing firm value
Takeovers
Shareholders vs. All Stakeholders
Employees
Customers
Suppliers
Communities
Nominal and Real Interest Rates
Nominal interest rates are the actual rates you
receive by investing in bank accounts, bonds
or other interest bearing securities
Nominal interest rates compensate you both
for the time value of money and the erosion of
purchasing power caused by inflation
Real interest rates are the returns in excess of
the rate of inflation
Nominal Interest Rates
Combines inflation and real interest rates

1+i = {(1+q) x (1+r)}

where i = nominal interest rate
q = inflation rate
r = real interest rate
Inflation and nominal interest rates are highly
correlated
Next Class
Valuation of Bonds and Common Stock
Student presentations
Bond valuation
Stock valuation
Read Chapter 4 in the text