Concept of Present Value

WHY IS THE CONCEPT OF PRESENT VALUE SO w octettey FOR CORPORATE FINANCE? The brilliance of concept of present nurse to the reality of corpo roll finance is that present value calculations atomic number 18 widely apply in business and economics to provide a means to discriminate immediate salaryment flows at different times. mystify entertains rendering and simplistic regulation used for normal purchases, the concepts sizeableness to corporate finance and why present value is the very premier(prenominal) egress taught in finance classes explain that present value is an subjective knowledgeable tool to ensure we make the best decisions with our money. However, first, What Does give up Value PV Mean?Present value is the current worth of a rising sum of money or stream of cash flows given a specified rate of return. Future cash flows are deductioned at the discount rate, and the higher the discount rate, the lower the present value of the upcoming cash flows. Determ ining the appropriate discount rate is the key to properly valuing future cash flows, whether they are earnings or obligations. Through the definition itself, an importance to corporate finance is explained as well as why professors bulge a finance course with a basis explanation in the time value of money discounting and investment risk included.In more(prenominal) detail, capital investment decisions are long-term corporate finance decisions relating to stubborn assets and capital structure. Decisions are made with several criteria to consider, and where corporate management seeks to maximize value in the firm by the correctly calculated bring in present value when valued using an appropriate discount rate. It would be beneficial on a personal level for the following reasons eruditeness how to use a financial calculator to make present value calculations can help you decide whether you should accept a cash rebate, 0% financing on the purchase of a car or to pay points on a mortgage. Present value could often the first topic taught in any finance class, due to the fact that knowledge of this formula can be used for basic financial planning that leave behind lead to larger level strategy making the best social club investment decisions. Now, on to the fun stuff that is so anxiously taught in class the problems and formulas. 2a. $500 if invested for five years at a 4% interest rate FV = 500 (1 + . 04)1) = 500 (1. 04) = $520. 00 FV = 520 (1 + . 04)2) = 520 (1. 0816) = $540. 80 FV = 540. 80 (1 + . 04)3) = 540. 80 (1. 124864) = $562. 43 FV = 562. 43(1 + . 04)4) = 562. 43(1. 169859) = $584. 3 FV = 584. 93(1 + . 04)5) = 584. 93 (1. 216653) = $608. 33 finis of Year12345 Principal$500. 00$520. 00$540. 80$562. 43$584. 93 Interest$20. 00$20. 80$21. 63$22. 50$23. 40 tot$520. 00$540. 80$562. 43$584. 93$608. 33 2b. $ one hundred fifty if invested for tercet years at a 9% interest rate FV = 150 (1 + . 09)1) = 150 (1. 09) = $163. 50 FV = 163. 50(1 + . 09)2) = 1 63. 50(1. 1881) = $178. 22 FV = 178. 22 (1 + . 09)3) = 178. 22 (1. 295029) = $194. 25 End of Year123 Principal$150. 00$163. 50$178. 22 Interest$13. 50$14. 72$16. 04 Total$163. 50$178. 22$194. 25 2c. $9100 if invested for seven years at a 3% interest rateFV = 9100 (1 + . 03)1) = 9100 (1. 03) = $9373 FV = 9373 (1 + . 03)2) = 9373 (1. 0609) = $9654. 19 FV = 9654. 19 (1 + . 03)3) = 9654. 19 (1. 092727) = $9943. 82 FV = 9943. 82 (1 + . 03)4) = 9943. 82 (1. 12550881) = $10242. 13 FV = 10242. 13 (1 + . 03)5) = 10242. 13 (1. 15927407) = $10549. 39 FV = 10549. 39 (1 + . 03)6) = 10549. 39(1. 1940523) = $10865. 88 FV = 10865. 88(1 + . 03)7) = 10865. 88 (1. 22987387) = $11191. 85 End of Year1234567 Principal$9,100. 00$9,373. 00$9,654. 19$9,943. 82$10,242. 13$10,549. 39$10,865. 88 Interest$273. 00$281. 19$289. 63$298. 31$307. 26$316. 48$325. 8 Total$9,373. 00$9,654. 19$9,943. 82$10,242. 13$10,549. 39$10,865. 88$11,191. 85 2d. $1000 if invested for ten years at a 0. 5% interest rate FV = 1000 (1 + . 005)1) = 1000 (1. 005) = $1005 FV = 1005 (1 + . 005)2) = 1005 (1. 010025) = $1010. 03 FV = 1010. 03 (1 + . 005)3) = 1010. 03 (1. 01507513) = $1015. 08 FV = 1015. 08 (1 + . 005)4) = 1015. 08 (1. 020150501) = $1020. 15 FV = 1020. 15 (1 + . 005)5) = 1020. 15 (1. 02525125) = $1025. 25 FV = 1025. 25 (1 + . 005)6) = 1025. 25(1. 03037751) = $1030. 38 FV = 1030. 38(1 + . 005)7) = 1030. 38 (1. 0355294) = $1035. 53 FV = 1035. 53 (1 + . 05)8) = 1035. 53 (1. 040707) = $1040. 71 FV = 1040. 71 (1 + . 005)9) = 1040. 71(1. 0459106) = $1045. 91 FV = 1045. 91(1 + . 005)10) = 1045. 91 (1. 0511401) = $1051. 14 End of Year12345 Principal$1,000. 00$1,005. 00$1,010. 03$1,015. 08$1,020. 15 Interest$5. 00$5. 02$5. 05$5. 08$5. 10 Total$1,005. 00$1,010. 03$1,015. 08$1,020. 15$1,025. 25 End of Year678910 Principal$1,025. 25$1,030. 38$1,035. 53$1,040. 71$1,045. 91 Interest$5. 13$5. 15$5. 18$5. 20$5. 23 Total$1,030. 38$1,035. 53$1,040. 71$1,045. 91$1,051. 14 Present Value 3a. $7700 to be legitimate three y ears from now with a 5% interest ratePV = 7700 / (1 + . 05) 3 = 7700 / (1. 157625) = $6651. 55 3b. $1500 to be received five years from now with a 7% interest rate PV = 1500 / (1 + . 07) 5 = 1500 / (1. 4025517) = $1069. 48 3c. $7200 to received two years from now with an 11% interest rate PV = 7200 / (1 + . 11) 2 = 7200 / (1. 2321) = $ 5843. 68 3d. $ 680,000 to be received eight years from now with a 9% interest rate. PV = 680000 / (1 + . 09) 8 = 680000 / (1. 9925626) = $341269. 07 duration Value of Money Annuities 4. Present Value Annuity / Suppose you are to receive an annuity of $3000 every year for 3 years 3% interest rate.PV = PVAF(r,n)*CF PVAF(r,n) = 1/r 1/r*(1+r)n (33. 33 30. 50472 = 2. 828611) PV = 2. 828611*3000 PV = $ 8485. 83 5. Future Value Annuity / Suppose you receive a hire of $5000 every year for 3 years, depositing into a bank that pays 2% interest. FV = CF * FVAF (r,n) FVAF(r,n) = 1/r 1/r*(1+r)n (50 47. 11612 = 2. 883883) FV = 5000 * 2. 883883 FV = $1 4419. 42 REFERENCES anonymous (2010). Investopedia. com. Present Value. Retrieved on 5 Apr 2010 http//www. investopedia. com/terms/p/presentvalue. asp 2 Megginson, William (2008). Corporate Finance. Stamford Thomson Learning. P. 86. Anonymous (2010). Investopedia. com. Explaining Present Value-PV. Retrieved on 5 Apr 2010 http//www. investopedia. com/terms/p/presentvalue. asp 4 Anonymous (n. d). FinanceProfessor. com. Future Value. Retrieved on 3 Apr 2010 from http//www. financeprofessor. com/fiancnenotes/introductoryfin/presentvalue. htm 5 Anonymous (n. d). FinanceProfessor. com. Present Value. Retrieved on 3 Apr 2010 from http//www. financeprofessor. com/fiancnenotes/introductoryfin/presentvalue. htm 6 Anonymous (2008). The Time Value of Money. Retrieved on 4 Apr 2010 from http//www. econedlink. org/lessons/index. cfm? lesson=EM37