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Chapter 5

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


Department
Rady School of Management
Course Code
MGT 181
Professor
Buchanan
Chapter
5

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Introduction to Valuation: The Time Value of Money
Time value of money
A dollar you have today is worth more than a dollar promised in the future
Money you have in hand can be immediately invested to bring you more money
Future Value and Compounding
Investing for a Single Period
Future value (FV)
The amount an investment is worth after one or more periods
If you invest $100 for one year at 10% interest rate, the FV of that $100 is $110
$100 + (100*.1) = 110
INvesting for More than One Period
Compounding
The process of accumulating interest on an investment over time to earn more
interest
Interest on interest
Interest earned on the reinvestment of previous interest payments
Compound interest
Interest earned on both the initial principal and the interest reinvested from prior
periods
Simple interest
Interest earned only on the original principal
If you invest $100 for two years at 10%, the FV is $121
After year one you have $110 in the bank, and $110 * .1 = 121
You collect interest on your interest (the $10)
Future value = P(1+r)t
P = principal
(1+r)t is sometimes called the future value (interest) factor
A Note About Compound Growth
Doesn’t just have to be used for investments, can be used for anything that grows
exponentially
Employees, profits, etc.
Present Value and Discounting
The Single-Period Case
Present value (PV)
The current value of future cash flows discounted at the appropriate discount rate
How much we have to invest today to get a desired amount at the end of a certain
period
PV = P/(1=r)
For one period
Discount
Calculate the present value of some future event
Present Values for Multiple Periods
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