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Chapter 5

Introduction toValuation: The TimeValue of Money

McGraw-Hill/Irwin

Copyright 2012 by McGraw-Hill Education (Asia). All rights reserved.

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McGraw-Hill/Irwin

Copyright 2012 by McGraw-Hill Education (Asia). All rights reserved.

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Obviously, $10,000 today.

The question is to ask that why do you prefer

$10,000 today?

Imagine that your parent offers youeither $ 10,000 today or $ 10,000 in

five years time. Faced with thischoice, which would you prefer --

$10,000 today$10,000 today or $10,000 in 5 years$10,000 in 5 years

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Solution: !here are three ma"or factors

Tie: If you have the money now, you can spend it now. It is humannature to want things now rather than wait for them. #lternatively, ifyou do not want to spend money now, you can invest it, so that in 5years time you will earn interest

!nflation: $ 10,000 spent now will uy oregoods % services that

$10,000 spent in 5 years time ecause inflation undermines thepurchasing power of your money.

"isk: If you ta&e $ 10,000 now you definitely have the money inyour possession. !he alternative of the promise of 10,000 in 5 yearstime carries the ris& that the payment may e less that $10,000 or

may not e paid at all.

A dollar in hand today is worth more than a

dollar promised some time in the future.

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'tudent should e ale to (

) *alculate the future value of an investment madetoday

) *alculate the present value of cash to e receivedat some future date

) *alculate the return on an investment

) *alculate the time needed for an investment toreach a desired value.

5*-5

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*hapter +utline

5.1. Future alue and *ompounding

5.. resent alue and /iscounting

5.. ore aout resent and Future alues

5*-2

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3asic /efinitions

) #resent alue4 the value of a cash flow at anearlier period on a time line

!ranslating a future value to a present value discounting

) %uture alue4 the value of a cash flow at sometime in the future.

*overting a present value to a future value compounding

) &nnuity4 a finite series of e6ual payment thatoccur at regular interval.78amples of annuities (

Installment loans car loan, mortgages 9:;