Chapter 2 Net Present Value and Investment Decision
Chapter 2 Chapter 2 Net Present Value and Net Present Value and Investment Decision Investment Decision
Section 1 Net Present Value
Section 1 Section 1 Net Present Value Net Present Value
Time Value of Money Cash flows occur over a period of time Inflation erodes the value of money over time -What are the value of those cash flows in TODAY'S money slide 2
slide 2 Time Value of Money Time Value of Money Cash flows occur over a period of time Inflation erodes the value of money over time What are the value of those cash flows in TODAY’S money
The time value of money(1) To study the relationship between a dollar today and a (possible uncertain) dollar in the future Future Present value PV= C 1+r slide 3
slide 3 The time value of money (1) The time value of money (1) To study the relationship between a dollar today and a (possible uncertain) dollar in the future Future Present value r C PV + = 1 1
The time value of money (2) Net Present Value NPV=-Cost+PV Future Value and Compounding Simple interest:FV C *(1 +T *r) Compound interest:FV=C (1+r) slide 4
slide 4 The time value of money (2) The time value of money (2) Net Present Value Future Value and Compounding Simple interest: FV = C * (1 + T *r) Compound interest: FV = C * (1+r) T NPV = − + PVCost
Example Julie wants to know how large her $10,000 deposit will become at a compound interest rate of for 5 years. 1 2 3 4 5 |10% $10,000 FV5 slide 5
slide 5 Julie wants to know how large her $10,000 $10,000 deposit will become at a compound interest rate of for 5 years. 5 years Example Example 0 1 2 3 4 5 $10,000 $10,000 FV 5 10%
Solution Calculation based on general formula: FVn Po(1+i)n FV5=$10,000(1+0.10)5 =$16,105.10 slide 6
slide 6 Solution Solution Calculation based on general formula: FVn = P0 (1+i)n FV5 = $10,000 (1+ 0.10)5 = $16,105.10 $16,105.10
Problem Julie wants to know how large a deposit to make so that the money will grow to $10,000 in 5 years at a discount rate of 10%. 1 2 3 4 5 10% $10,000 slide 7
slide 7 Problem Problem Julie wants to know how large a deposit to make so that the money will grow to $10,000 $10,000 in 5 years at a discount rate of years 10%. 0 1 2 3 4 5 $10,000 $10,000 PV0 10%
Solution Calculation based on general formula: PVo FVn/(1+i)n PV0=$10,000/(1+0.10)5 =$6,209.21 slide 8
slide 8 Solution Solution Calculation based on general formula: PV0 = FVn / (1+i)n PV0 = $10,000 / (1+ 0.10) $10,000 5 = $6,209.21 $6,209.21
The Power of Compounding The US stock market returned as a whole from 1926 through 1996 (annual rate of return is 10.71%) Simple interest: $1*(1+71*10.71%)=$7.6 Compound interest: $1*(1+10.71%)71=$1371.71 slide 9
slide 9 The Power of Compounding The Power of Compounding The US stock market returned as a whole from 1926 through 1996 (annual rate of return is 10.71%) Simple interest: $1* ( 1+71*10.71%)=$7.6 Compound interest: $1* (1+10.71%)71=$1371.71