slide thuyết trình TIME VALUE OF MONEY AND DCF MODEL

TIME VALUE OF MONEY AND DCF MODEL “I think being in love with life is a key to eternal youth.” —Doug Hutchison ThS Nguyễn Thị Thu Trang download by : skknchat@gmail.com LECTURE CONTENT • Part 1: Time value of money • The importance of time value of money • Single cash flow formula • Simple interest and compound interest • Present value and future value of cash flows • Part 2: Discounted cash flow valuation model ThS Nguyễn Thị Thu Trang download by : skknchat@gmail.com OBJECTIVE LEARNING Explain what the time value of money is and why it is so important in the field of finance Explain the concept of future value, including the meaning of the terms principal, simple interest and compound interest, and use the future value formula to make business decisions Explain the concept of present value, how it relates to future value, and use the present value formula to make business decisions ThS Nguyễn Thị Thu Trang download by : skknchat@gmail.com TIME VALUE OF MONEY Opportunity cost Risk ThS Nguyễn Thị Thu Trang download by : skknchat@gmail.com Inflation Why Is The Time Value of Money Important? Put two CFs in comparable terms ThS Nguyễn Thị Thu Trang download by : skknchat@gmail.com SINGLE CASH FLOW FORMULA PV0 FV1 FV! = PV(1 + i) n = Number of period ThS Nguyễn Thị Thu Trang download by : skknchat@gmail.com SIMPLE INTEREST Time $10 Interest Earned Amount at the end of each period, FVn 10% ? $100*10% = $10 $100 + $10 = $110 ? $100*10% = $10 ? $100*10% = $10 $110 + $10 = $120 $120 + $10 = $130 • The interest in each period is earned only using the original principal ThS Nguyễn Thị Thu Trang download by : skknchat@gmail.com ANNUITY DUE - EXAMPLE • Suppose you rent a house for $12,000 a year and deposit all the money received each year at the 10% annual compound interest savings account, the first deposit occur immediately Ask how much money you will have at the end of the third year? • Kathy’s uncle promised her an allowance of $1,000 per year, starting today, with a final payment to be made at the beginning of Year If the interest rate is 7% per year, what is the present value of these cash flows? ThS Nguyễn Thị Thu Trang download by : skknchat@gmail.com PRESENT VALUE OF A PERPETUITY • A perpetuity is the cash flow with inflows or outflows incurred forever • We have present value of normal cash flows PVA = CF • n Khi n ∞ 1/i(1+i) 0, lúc đó: PVA " = CF i −0= CF i • Using to valuate preference stock ThS Nguyễn Thị Thu Trang download by : skknchat@gmail.com FUTURE VALUE OF MULTIPLE CASH FLOWS Time $300 • Q1:You deposit $100 in Year 1, $200 in Year and $300 in Year How much will you have in years with 7% interest per annum $300 $214=200(1.07) • Q2: How much will it be in years if you don’t add additional cash? $114.49=100(1.07) FV at Year Solution ThS Nguyễn Thị Thu Trang download by : skknchat@gmail.com $628.49 628.49(1.07) $719.56 FV at Year FUTURE VALUE OF MULTIPLE CASH FLOWS Time 7% • Q1:You deposit $100 in Year 1, $200 in Year and $300 in Year How much will you have in years with 7% interest per annum =300(1.07) • Q2: How much will it be in years if you don’t add additional cash? =200(1.07) =100(1.07) Solution FV at Year ThS Nguyễn Thị Thu Trang download by : skknchat@gmail.com $343.47 $245.01 $131.08 $719.56 PRESENT VALUE OF MULTIPLE CASH FLOWS Time You are offered an investment that will pay $200 in Yr 1, $400 in Yr 2, $600 in Yr and $800 at the end of Yr 4.You can earn 12% on similar investments What is the most you should pay for this one? $178.57 $318.88 $427.07 $508.41 PV $178.57 ThS Nguyễn Thị Thu Trang download by : skknchat@gmail.com FUTURE VALUE AND PV OF MULTIPLE CASH FLOWS Case study: we have cash flows generated through the years below, calculate the PV and FV of this cash flow, indicating the discount rate of 7% How much will it be in years if you don’t add additional cash? ThS Nguyễn Thị Thu Trang download by : skknchat@gmail.com Effective Annual Rates of Interest • A reasonable question to ask in the above example is “what is the effective annual rate of interest on that investment?” • FV" = 100x(1 + # % &'" & ) = 100x(1.05)(=$134 • The Effective Annual Rate (EAR) of interest is the annual rate that would give us the same end-of-investment wealth after years: • 100 x (1+EAR) = $134 ThS Nguyễn Thị Thu Trang download by : skknchat@gmail.com Effective Annual Rates of Interest • FV3 = 100 x (1 + EAR) = $134 • (1 + EAR)"= %") %## = 1.34 ! • EAR = 1.34" − = 0.1025 = 10.25% • So, investing at 10.25 % compounded annually is the same as investing at 10% compounded semiannually ThS Nguyễn Thị Thu Trang download by : skknchat@gmail.com The Discounted Cash Flow Model - DCF • The discounted cash flow model is built on the basis of the concept of monetary price and the relationship between profit and risk (will be detailed in the following chapters) PV = CF % % (1 + r) ! CF =A /% ThS Nguyễn Thị Thu Trang (1 + r) download by : skknchat@gmail.com DCF MODEL APPLICATION Asset valuation, including tangible assets and financial assets, to decide whether to buy or sell the property Analyze, evaluate and make decisions on whether or not to invest in an investment project Analyzing, evaluating and deciding whether to buy or rent a fixed asset Analyze, evaluate and decide whether or not to buy a business ThS Nguyễn Thị Thu Trang download by : skknchat@gmail.com ... CONTENT • Part 1: Time value of money • The importance of time value of money • Single cash flow formula • Simple interest and compound interest • Present value and future value of cash flows •... of present value, how it relates to future value, and use the present value formula to make business decisions ThS Nguyễn Thị Thu Trang download by : skknchat@gmail.com TIME VALUE OF MONEY Opportunity... skknchat@gmail.com The Discounted Cash Flow Model - DCF • The discounted cash flow model is built on the basis of the concept of monetary price and the relationship between profit and risk (will be detailed in