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Spring 2012 Semester - J. K. Dietrich
Present Value Analysis and Formulas
(1) Any single future cash flow can be discounted or its present value calculated using
the general formula (Text, p. 98):
. Example:
8384 $.
) 0316 . 1 (
1 $
PV
665 . 5
+
r
C
PV
Single Cash Flow
Sequence of Cash Flows
Perpetuity
15 . 155 , 6 $
) 054 . 1 (
1200 $
) 054 . 1 (
1550 $
) 054 . 1 (
1720 $
) 054 . 1 (
1500 $
) 054 . 1 (
1220 $
PV
5 4 3 2 1
+
+
+
+
+
+
+
+
+
62 . 25 $
01555 .
39844 $.
PV
+
+ +
+
+
+
+
+
T t
1 t
i
i
T
T
3
3
2
2
1
1
) r 1 (
C
) r 1 (
C
) r 1 (
C
) r 1 (
C
) r 1 (
C
PV
(4) If you can assume that a beginning (first period) cash flow will grow after the first
period at a constant rate g, the present value of the cash flows can be calculated using the
growing perpetuity formula (Text, p. 108):
Example:
A building has first-month after tax cash flow (rental income net of
operating costs) of $10,500 and are expected to increase at the
assumed annual inflation rate of 2%, while real estate is currently
being capitalized at 10%, yielding a value of $1.5 million.
Graphical representation of cash flows for a growing perpetuity:
(5) If a cash flow is paid annually (or periodically) for T periods the present value of the
payments can be calculated using the annuity formula (Text, p. 111):
Example:
You require $10,000 per year at the end of each year for
tuition and have a savings account paying 2.5% = .025
interest. You must have $37,620 in the account one-year
before first payment is due.
(6) If you can assume that a beginning (first period) cash flow will grow after the first
period at a constant rate g for T periods, the present value of the cash flows can be
calculated using the growing annuity formula (Text, p. 115):
Example:
You plan to start saving $2,000 next year expecting
an 8% = .08 return and you plan that your annual
saving will grow at 2.5% = .025 after the first year.
Graphical representation of annuity and growing annuity:
Graduate School of Business Administration 548 - Corporation Finance MBA.PM
[2/24/2012]
0
Time
C
a
s
h
F
l
o
w
1
]
1
+
T
) r 1 ( r
1
r
1
C PV
1
1
]
1
,
_
+
+
T
r 1
g 1
x
g r
1
g r
1
C PV
0
C
a
s
h
F
l
o
w
Time
T
620 , 37 $
) 025 . 1 ( 025 .
1
025 .
1
000 , 10 $ PV
4
1
]
1
+
000 , 575 , 1 $
12 / ) 02 . 10 (.
500 , 10 $
PV
g r
C
PV
1
1
]
1
,
_
+
+
25
08 . 1
025 . 1
x
025 . 08 .
1
025 . 08 .
1
000 , 2 $ PV
520 , 26 $ PV
Growing Perpetuity
Annuity
Growing Annuity
Annuity
Spring 2012 Semester - J. K. Dietrich
Summary of Present Value Formulas
.
.
GENERAL FORMULAS
.
PERPETUAL CASH FLOWS FOR QUICK CALCULATIONS
CASH FLOWS OVER LIMITED TIME HORIZON PRACTICAL
[2/24/2012]
0
Time
C
a
s
h
F
l
o
w
1
]
1
+
T
) r 1 ( r
1
r
1
C PV
1
1
]
1
,
_
+
+
T
r 1
g 1
x
g r
1
g r
1
C PV
0
C
a
s
h
F
l
o
w
Time
T
T
T
) r 1 (
C
PV
+
r
C
PV
g r
C
PV
+
+ +
+
+
+
+
+
T t
1 t
i
i
T
T
3
3
2
2
1
1
) r 1 (
C
) r 1 (
C
) r 1 (
C
) r 1 (
C
) r 1 (
C
PV
Growing Annuity
C
a
s
h
F
l
o
w
0
Sequence of Cash Flows