Present Value: Discounted Value of the Future Cash Flows

Topics

Present value: Discounted value of the future cash flows

Ex:

Net present value (NPV): NPV = Present value of net cash flows.

How risk figures into calculations of value: A safe dollar is worth more than a risky one. Most investors avoid risk when they can do so without sacrificing return.

Opportunity cost of capital (where it comes from and how it is used): Opportunity cost of capital is the expected rate of return on alternative investments which is used to compute the value of the investment through the assessment of risk. The investment can only be valued against the opportunity cost of capital, the alternative investment if the investment was not taken.

Value of a stream of cash flow such as bond, annuity, perpetuity

A perpetuity is an annuity in which the periodic payments begin on a fixed date and continue indefinitely.

Where PV = Present Value of the Perpetuity, A = the Amount of the periodic payment, and r = yield , discount rate or interest rate.

Annuity is used in finance theory to refer to any terminating stream of fixed payments over a specified period of time.

Why NPV rule dominates the other alternatives

NPV depends on only the project’s cash flows and the opportunity cost of capital.

How to read a basic balance sheet and calculate the cash flows