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Chapter 5

# MGT 181 Chapter Notes - Chapter 5: Discounted Cash Flow, Discount Window, Compound Interest

Department
Course Code
MGT 181
Professor
Buchanan
Chapter
5

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Introduction to Valuation: The Time Value of Money
β Time value of money
β A dollar you have today is worth more than a dollar promised in the future
β Money you have in hand can be immediately invested to bring you more money
Future Value and Compounding
Investing for a Single Period
β Future value (FV)
β The amount an investment is worth after one or more periods
β If you invest \$100 for one year at 10% interest rate, the FV of that \$100 is \$110
β \$100 + (100*.1) = 110
INvesting for More than One Period
β Compounding
β The process of accumulating interest on an investment over time to earn more
interest
β Interest on interest
β Interest earned on the reinvestment of previous interest payments
β Compound interest
β Interest earned on both the initial principal and the interest reinvested from prior
periods
β Simple interest
β Interest earned only on the original principal
β If you invest \$100 for two years at 10%, the FV is \$121
β After year one you have \$110 in the bank, and \$110 * .1 = 121
β You collect interest on your interest (the \$10)
β Future value = P(1+r)t
β P = principal
β (1+r)t is sometimes called the future value (interest) factor
β Doesnβt just have to be used for investments, can be used for anything that grows
exponentially
β Employees, profits, etc.
Present Value and Discounting
The Single-Period Case
β Present value (PV)
β The current value of future cash flows discounted at the appropriate discount rate
β How much we have to invest today to get a desired amount at the end of a certain
period
β PV = P/(1=r)
β  For one period
β Discount
β Calculate the present value of some future event
Present Values for Multiple Periods