Principles of

Chapter 2 Corporate Finance

Tenth Edition

How to Calculate
Present Values

Slides by
Matthew Will

McGraw-Hill/Irwin Copyright © 2011 by the McGraw-Hill Companies, Inc. All rights reserved.
 2-2

Key terms
• Present value: Giá trị hiện tại
• Future value: Giá trị tương lai
• Discount factor: Nhân tố chiết khấu
• Annuity: Hàng năm
• Perpetuities: Vĩnh viễn
• Compound: Ghép
• Simple interest : lãi đơn
• Compound interest: lãi kép
• Rate of return: Tỷ suất sinh lời
• Cash flow: dòng tiền
• EAR (Effective Annual Rate): tỷ suất sinh lợi hiệu dụng năm.
• APR (Annual Percentage Rate): Lãi suất năm
 2-3

Topics Covered
Single payment cashflow
1
Multiple payment cashflows and NPV
2
Annuity and Perpetuity
3 Growth Annuity and Growth Perpetuity
Discount Factor
4 APR and EAR
 2-4

Present and Future Value

Future Value
Amount to which
an investment will
grow after earning
Present Value interest

Value today of
a future cash
flow.
Present Value & Future Value 2-5

1 year

PV: Present value

C1: Future value one year
r: discount rate per year
Present Value & Future Value 2-6

n year

PV: Present value

C1: Future value one year
r: discount rate per year
n: number of year
 Present Values & Future Values 2-7

Definition

• Present Value is defined as future cash flows discounted to the

present at an appropriate discount rate.
• PV (x + y) = PV (x) + PV (y)
• The rate of return is also called: I) discount rate; II) hurdle rate;
III) opportunity cost of capital
• The present value formula for one period cash flow is PV =
C1/(1 + r)
• The concept of compound interest is most appropriately
described as interest earned on interest.
• The process of discounting is the inverse of the process of
compounding.
 2-8

Present Value

Discount Factor = DF = PV of $1

DF = 1
(1+ r ) t

Discount Factors can be used to compute the present

value of any cash flow.
 Present Value & Future Value 2-9

n year – discount rate paid daily / monthly…

PV: Present value

C1: Future value one year
r: discount rate per year / APR
n: number of year
m: 365 (daily), 12 (monthly), 4 (quarterly), 2 (semi-annually)
Present Value & Future Value 2-10

Cash flow

PV: Present value

Cn: Future value n year
r: discount rate per year
n: number of year
 2-11

Net Present Value

NPV: Net Present value

Co < 0: Initial investment
Cn: Future value n year
r: discount rate per year
n: number of year
 Net Present Value rule 2-12

Definition
• The net present value formula for one period is:
• NPV = C0 + [C1/(1 + r)]
• NPV = PV required investment
• NPV rule and the rate of return rule:
• Accept a project if its NPV > 0
• Reject a project if the NPV < 0
• Accept a project if its rate of return > opportunity cost of
capital
• The opportunity cost of capital for a risky project is the expected
rate of return on a portfolio of securities of similar risks as the
project.
• The discount rate is used for calculating the NPV is determined by
the financial markets.
• The managers of a firm can maximize stockholder wealth by
taking all projects with positive NPVs
 2-13

Annuity & Perpetuity

Annuity - An asset that pays a fixed sum each year for a specified
number of years.

Perpetuity - Financial concept in which a cash flow is

theoretically received forever.
 2-14

Short Cuts
Annuity - An asset that pays a fixed sum
each year for a specified number of
years.

1 1 
PV of annuity = C   − t
 r r (1 + r ) 
 2-15

Annuity Short Cut

Example
You agree to lease a car for 4 years at $300 per
month. You are not required to pay any money up
front or at the end of your agreement. If your
opportunity cost of capital is 0.5% per month, what is
the cost of the lease?
 2-16

Annuity Short Cut

Example - continued
You agree to lease a car for 4 years at $300
per month. You are not required to pay any
money up front or at the end of your
agreement. If your opportunity cost of
capital is 0.5% per month, what is the cost of
the lease?

 1 1 
Lease Cost = 300   − 48 
 .005 .005(1 + .005) 
Cost = $12,774.10
 2-17

Annuity Short Cut

Example
The state lottery advertises a jackpot prize of $295.7
million, paid in 25 installments over 25 years of
$11.828 million per year, at the end of each year. If
interest rates are 5.9% what is the true value of the
lottery prize?
 1 1 
Lottery Value = 11.828   − 25 
 .059 .059(1 + .059) 
Value = $152,600,000
 2-18

FV Annuity Short Cut

Future Value of an Annuity – The future value
of an asset that pays a fixed sum each year
for a specified number of years.

 (1 + r ) − 1
t
FV of annuity = C   
 r 
 2-19

Annuity Short Cut

Example
What is the future value of $20,000 paid at the end of
each of the following 5 years, assuming your
investment returns 8% per year?

 (1 + .08)5 − 1
FV = 20,000   
 .08 
= $117,332
 2-20

N-year annuity factor

r: discount rate per year

n: number of year
 2-21

Growing annuity

r: discount rate per year

n: number of year
C: Cash flow per year
g: growth rate
 2-22

Constant Growing Perpetuity

C1
PV0 =
r−g

g = the annual growth

rate of the cash flow
 2-23

Constant Growth Perpetuity

NOTE: This formula can

be used to value a
perpetuity at any point in
time.
C t +1
P Vt =
r−g
C1
PV0 =
r−g
 2-24

Constant Growth Perpetuity

Example
What is the present value of $1 billion paid at the end
of every year in perpetuity, assuming a rate of return
of 10% and a constant growth rate of 4%?

1
PV0 =
.10 − .04
= $16.667 billion
 2-25

Effective Interest Rates

Effective Annual Interest Rate - Interest

rate that is annualized using compound
interest.

Annual Percentage Rate - Interest rate

that is annualized using simple interest.
 2-26

Effective Interest Rates

 2-27

Effective Interest Rates

Example
Given a monthly rate of 1%, what is the
Effective Annual Rate(EAR)? What is the
Annual Percentage Rate (APR)?
 2-28

Effective Interest Rates

Example
Given a monthly rate of 1%, what is the
Effective Annual Rate(EAR)? What is the
Annual Percentage Rate (APR)?

12
EAR = (1 + .01) - 1 = r
EAR = (1 + .01)12 - 1 = .1268 or 12.68%

APR = .01 x 12 = .12 or 12.00%

 2-29

Web Resources
Click to access web sites
Internet connection required

www.smartmoney.com
http://finance.yahoo.com
www.in.gov/ifa/files/TollRoadFinancialAnalysis.pdf
www.mhhe.com/bma
 Review Chapter 2 2-30

PV, FV definition

• Present Value is defined as future cash flows discounted to the

present at an appropriate discount rate.
• PV (x + y) = PV (x) + PV (y)
• The rate of return (r) is also called: I) discount rate; II) hurdle
rate; III) opportunity cost of capital
• The present value formula for one period cash flow is PV =
C1/(1 + r)
• The concept of compound interest is most appropriately
described as interest earned on interest.
• The process of discounting is the inverse of the process of
compounding.
 Review Chapter 2 2-31

Net Present Value rule

• The net present value formula for one period is:
• NPV = C0 + [C1/(1 + r)]
• NPV = PV required investment
• NPV rule and the rate of return rule:
• Accept a project if its NPV > 0
• Reject a project if the NPV < 0
• Accept a project if its rate of return > opportunity cost of
capital
• The opportunity cost of capital for a risky project is the expected
rate of return on a portfolio of securities of similar risks as the
project.
• The discount rate is used for calculating the NPV is determined by
the financial markets.
• The managers of a firm can maximize stockholder wealth by
taking all projects with positive NPVs
 2-32

Review Chapter 2
Công thức tổng quát:

Ứng dụng thực tế:

PV: Present value

Cn: Future value n year NPV: Net Present value
r: discount rate per year Co < 0: Initial investment
n: number of year
 2-33

Review Chapter 2

m: số kỳ ghép lãi trong năm

PV: Present value
Cn: Future value n year
n: number of year
r: discount rate per year, rate of return, interest rate, cost of capital, APR (Annual
percentage rate)
EAR (Effective annual rate): lãi suất hiệu dụng năm
 2-34

Review Chapter 2

PV: Present value at beginning of year 0

FV: Future value at the end of year n
C: Cash flow at the end of each year
r: discount rate per year
n: number of year
 2-35

Review Chapter 2
n – year discount factor n – year annuity discount factor

Discount factor PV n – year annuity factor FV n – year annuity factor

(DF) (PVAF) (FVAF)

DF: nhân tố chiết khấu của dòng tiền chỉ có phát sinh C0, để tính PV
PVAF: nhân tố chiết khấu của dòng tiền annuity, để tính PV
FVAF: nhân tố chiết khấu của dòng tiền annuity, để tính FV
 2-36

Review Chapter 2

PV: Present value at beginning of year 0

FV: Future value at the end of year n
C: Cash flow at the end of each year
r: discount rate per year
n: number of year
g: growth rate (r > g)