Present Value

1
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

2
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

3
Net Present Value
NPV
n t0
?
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
4
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

5
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

6
Corporate Governance

• Role of Board of Directors
• Incentives to maximizing firm value
• Takeovers
• Shareholders vs. All Stakeholders
• Employees
• Customers
• Suppliers
• Communities

7
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

8
Nominal Interest Rates

• Combines inflation and real interest rates
• 1i (1q) x (1r)
• where i nominal interest rate
• q inflation rate
• r real interest rate
• Inflation and nominal interest rates are highly
  correlated

9
Next Class

• Valuation of Bonds and Common Stock
• Student presentations
• Bond valuation
• Stock valuation
• Read Chapter 4 in the text