Time Value of Money

Introduction

Many issues in Finance, but in the end what we want is to value some asset

Value = CF1 (1 + r)

n 1

+

CF2 (1 + r) .

2

+L+

CFn (1 + r) n

=∑

CFt r)

t

t =1 (1 +

To estimate an asset’s value, one estimates the cash flow for f each period t (CFt) the life of the asset ( ) and the h i d ), th lif f th t (n), d th appropriate discount rate (r)

© Weatherhead School of Management. Case Western Reserve University. 2009

WEATHERHEAD Bold Ideas. Lasting Impact.

1-1

Finance Boot Camp: Objectives

Value = CF1 (1 + r)

1

+

CF2 (1 + r)

2

+L+

CFn (1 + r) n

1. 1 Understand the concept and the mechanics of discounting 2. Determine the discount rate 3. Work out the concept of valuation for investment decisions

© Weatherhead School of Management. Case Western Reserve University. 2009

WEATHERHEAD Bold Ideas. Lasting Impact.

1-2

But There is More to Corporate Finance… Finance

Assets Liabilities

Investment decisions

In this boot camp we will deal solely with investment decisions. decisions Financing (long(long term and short-term) decisions are covered in BAFI 403.

Debt

Financing decisions Dividend policy decisions

Equity

Assets Liabilities

Current Fixed

Current LT debt Equity Eq it

Short-term financing g decisions

© Weatherhead School of Management. Case Western Reserve University. 2009

WEATHERHEAD Bold Ideas. Lasting Impact.

1-3

Now

Understand the concept and mechanics of discounting

How to take into consideration the time value of money?

© Weatherhead School of Management. Case Western Reserve University. 2009

WEATHERHEAD Bold Ideas. Lasting Impact.

1-4

Time Value of Money

What do you prefer, to have $1 prefer dollar today, or to receive $1 after one year?

$1 today!

© Weatherhead School of Management. Case Western Reserve University. 2009

WEATHERHEAD Bold Ideas. Lasting Impact.

1-5

Future Value

You deposit $100 in a bank paying 5%...