Professional Documents
Culture Documents
Concepts
Time Value of Money
Investment Decision Making
Risk and Return
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Corporate Finance
Peoplehave been running business for
thousands of years.
Corporate Finance is few decades old.
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Corporate Finance
Maximizing Value
Investment Decisions
Financing Decisions
Dividend Decisions
Tools
Time Value
Risk & Return
Applications
Leasing
Short Term Financial Management
Mergers and Acquisitions
Derivatives
International Finance
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Time Value of Money
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The Interest Rate
Which would you prefer -- Rs. 10,000
today or Rs. 10,000 in 5 years?
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Why TIME?
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Types of Interest
Simple Interest
Interest paid (earned) on only the original
amount, or principal, borrowed (lent).
Compound Interest
Interest paid (earned) on any previous
interest earned, as well as on the
principal borrowed (lent).
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Simple Interest Example
Assume that you deposit Rs. 1,000 in
an account earning 7% simple interest
for 2 years. What is the accumulated
interest at the end of the 2nd year?
SI = P0(i)(n)
= Rs. 1,000(.07)(2)
= Rs. 140
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Simple Interest (FV)
What is the Future Value (FV) of the
deposit?
FV = P0 + SI
= Rs. 1,000 + Rs. 140
= Rs. 1,140
FutureValue is the value at some future
time of a present amount of money, or a
series of payments, evaluated at a given
interest rate.
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Simple Interest (PV)
What is the Present Value (PV) of the
previous problem?
The Present Value is simply the
Rs. 1,000 you originally deposited.
That is the value today!
PresentValue is the current value of a
future amount of money, or a series of
payments, evaluated at a given interest
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rate.
Future Value
Single Deposit (Graphic)
Assume that you deposit Rs. 1,000
at a compound interest rate of 7%
for 2 years.
0 1 2
7%
Rs. 1,000
FV2
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Future Value
Single Deposit (Formula)
FV1 = P0 (1+i)1 = Rs. 1,000 (1.07)
= Rs. 1,070
Compound Interest
You earned Rs. 70 interest on your Rs.
1,000 deposit over the first year.
This is the same amount of interest you
would earn under simple interest.
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Future Value
Single Deposit (Formula)
FV1 = P0 (1+i)1 = Rs. 1,000 (1.07)
= Rs. 1,070
FV2 = FV1 (1+i)1
= P0 (1+i)(1+i) = Rs. 1,000(1.07)(1.07)
= P0 (1+i)2 = Rs. 1,000(1.07)2
= Rs. 1,144.90
You earned an EXTRA Rs. 4.90 in Year 2 with
compound over simple interest.
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General Future
Value Formula
FV1 = P0(1+i)1
FV2 = P0(1+i)2
etc.
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Present Value
Single Deposit (Graphic)
Assume that you need Rs. 1,000 in 2 years.
Lets examine the process to determine how
much you need to deposit today at a discount
rate of 7% compounded annually.
0 1 2
7%
Rs. 1,000
PV0 PV1
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Present Value
Single Deposit (Formula)
PV0 = FV2 / (1+i)2 = Rs. 1,000 / (1.07)2
= FV2 / (1+i)2 = Rs. 873.44
0 1 2
7%
Rs. 1,000
PV0
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General Present
Value Formula
PV0 = FV1 / (1+i)1
PV0 = FV2 / (1+i)2
etc.
Period 6% 7% 8%
1 .943 .935 .926
2 .890 .873 .857
3 .840 .816 .794
4 .792 .763 .735
5 .747 .713 .681
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Using Present Value Tables
PV2 = Rs. 1,000 (PVIF7%,2)
= Rs. 1,000 (.873)
= Rs. 873 [Due to Rounding]
Period 6% 7% 8%
1 .943 .935 .926
2 .890 .873 .857
3 .840 .816 .794
4 .792 .763 .735
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5 .747 .713 .681
Example
You want to know how large of a deposit to
make so that the money will grow to Rs. 10,000
in 5 years at a discount rate of 10%.
0 1 2 3 4 5
10%
Rs. 10,000
PV0
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Solution
Calculation based on general formula:
PV0 = FVn / (1+i)n
PV0 = Rs. 10,000 / (1+ 0.10)5
= Rs. 6,209.21
Calculation based on Table I:
PV0 = Rs. 10,000 (PVIF10%, 5)
= Rs. 10,000 (.621)
= Rs. 6,210.00 [Due to Rounding]
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Types of Annuities
AnAnnuity represents a series of equal
payments (or receipts) occurring over a
specified number of equidistant periods.
Ordinary Annuity: Payments or receipts
occur at the end of each period.
AnnuityDue: Payments or receipts
occur at the beginning of each period.
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Examples of Annuities
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Parts of an Annuity
(Ordinary Annuity)
End of End of End of
Period 1 Period 2 Period 3
0 1 2 3
0 1 2 3
FVAn
FVAn = R(1+i)n-1 + R(1+i)n-2 +
... + R(1+i)1 + R(1+i)0
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Example of an
Ordinary Annuity -- FVA
Cash flows occur at the end of the period
0 1 2 3 4
7%
Rs. 1,000 Rs. 1,000 Rs. 1,000
Rs. 1,070
Rs. 1,145
FVA3 = Rs. 1,000(1.07)2 +
Rs. 1,000(1.07)1 + Rs. 1,000(1.07)0 Rs. 3,215 = FVA3
= Rs. 1,145 + Rs. 1,070 + Rs. 1,000
= Rs. 3,215
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Valuation Using Exhibit 3
FVAn = R (FVIFAi%,n)
FVA3 = Rs. 1,000 (FVIFA7%,3)
= Rs. 1,000 (3.215) = Rs. 3,215
Period 6% 7% 8%
1 1.000 1.000 1.000
2 2.060 2.070 2.080
REVISE TABLE
3 3.184 3.215 3.246
4 4.375 4.440 4.506
5 5.637 5.751 5.867
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Overview of an
Ordinary Annuity -- PVA
Cash flows occur at the end of the period
0 1 2 n n+1
i% . . .
R R R
R = Periodic
Cash Flow
PVAn
PVAn = R/(1+i)1 + R/(1+i)2
+ ... + R/(1+i)n
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Example of an
Ordinary Annuity -- PVA
Cash flows occur at the end of the period
0 1 2 3 4
7%
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3. The aged but centrally located golf course you manage does
not have an in-ground automated water sprinkling system.
Instead, to properly water the course, sprinklers and hoses must
be repeatedly set, moved, and put away by some of the grounds
crewa tedious and laborious task. If over the next 12 years you
project annual savings of about $40,000 from having an
automated system, what is the maximum price you would be
willing to pay today for an installed, automated golf course
sprinkler system? (Assume an interest rate of 6%, and you may
ignore income taxes.)
a. Redo your calculation using a 10-year time period and $48,000
in annual savings.
b. Redo your initial calculation one more time using $50,000 in
annual savings for the first six years and $30,000 in annual
savings for the next six years.
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4. The cafeteria you operate has a regular clientele for all three
meals, seven days a week. You want to expand your product line
beyond what you are currently able to offer. To do so requires the
purchase of some additional specialty equipment costing $45,000,
but you project a resultant increase in sales (after deducting the
cost of sales) of about $8,000 per year for each of the next eight
years with this new equipment. Assuming a required rate of return
(i.e., a hurdle rate) of 8%, should you pursue this opportunity?
Why or why not? Do the analysis under two conditions:
a. You are part of an income-tax-exempt enterprise
b. The enterprise you are part of is subject to a 40% corporate
income tax rate and the straight-line, depreciable life of the
equipment you are contemplating purchasing is five years.
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5. You are contemplating the purchase of a one-half interest in a corporate
airplane to facilitate the expansion of your business into two new
geographic areas. The acquisition would eliminate about $220,000 in
estimated annual expenditures for commercial flights, mileage
reimbursements, rental cars, and hotels for each of the next 10 years. The
total purchase price for the share is $6 million, plus associated annual
operating costs of $100,000. Assume the plane can be fully depreciated,
on a straight-line basis, for tax purposes over 10 years. The companys
weighted average cost of capital (WACC) is 8%, and its corporate tax rate
is 40%. Does this endeavor present a positive or negative net present
value (NPV)? If positive, how much value is being created for the company
through the purchase of this asset? If negative, what additional annual
cash flows are needed for the NPV to equal zero? To what phenomena
might those additional positive cash flows be ascribable?
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6. The final tally is in: This years operating costs were
down $100,000, a decrease directly attributable to the
$520,000 investment in the automated materials handling
system put in place at the beginning of the year. If this level
of annual savings continues for five more years, resulting
in six total years of annual savings, what compounded
annual rate of return will that represent? If these annual
savings continue for nine more years, what compounded
annual rate of return will that represent? (You may ignore
income taxes.)
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Name:
Roll no: 123
How much you must save per year (at the end of the year) so that you can buy the property.
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