Present Value and The Opportunity Cost of Capital

Сентябрь 10, 2022

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Present Value and The Opportunity Cost of Capital

Содержание

2. Topics Covered Present Value Net Present Value NPV Rule ROR Rule Opportunity Cost of Capital Managers
3. Present Value Present Value Value today of a future cash flow. Discount Rate Interest rate used
4. Present Value
5. Present Value Discount Factor = DF = PV of $1 Discount Factors can be used to
6. Valuing an Office Building Step 1: Forecast cash flows Cost of building = C0 = 350
7. Valuing an Office Building Step 3: Discount future cash flows Step 4: Go ahead if PV
8. Net Present Value
9. Risk and Present Value Higher risk projects require a higher rate of return Higher required rates
10. Risk and Present Value
11. Rate of Return Rule Accept investments that offer rates of return in excess of their opportunity
12. Rate of Return Rule Accept investments that offer rates of return in excess of their opportunity
13. Net Present Value Rule Accept investments that have positive net present value
14. Net Present Value Rule Accept investments that have positive net present value Example Suppose we can
15. Opportunity Cost of Capital Example You may invest $100,000 today. Depending on the state of the
16. Opportunity Cost of Capital Example - continued The stock is trading for $95.65. Next year’s price,
17. Opportunity Cost of Capital Example - continued The stocks expected payoff leads to an expected return.
18. Opportunity Cost of Capital Example - continued Discounting the expected payoff at the expected return leads
19. Investment vs. Consumption Some people prefer to consume now. Some prefer to invest now and consume
20. Investment vs. Consumption
21. Investment vs. Consumption The grasshopper (G) wants to consume now. The ant (A) wants to wait.
22. Investment vs. Consumption The grasshopper (G) wants to consume now. The ant (A) wants to wait.
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Слайд 2

Topics Covered
Present Value
Net Present Value
NPV Rule
ROR Rule
Opportunity Cost of Capital
Managers and

the Interests of Shareholders

Слайд 3

Present Value
Present Value
Value today of a future cash flow.
Discount Rate
Interest rate

used to compute present values of future cash flows.

Discount Factor
Present value of a $1 future payment.

Слайд 4

Present Value

Слайд 5

Present Value
Discount Factor = DF = PV of $1
Discount Factors can

be used to compute the present value of any cash flow.

Слайд 6

Valuing an Office Building
Step 1: Forecast cash flows
Cost of building =

C0 = 350
Sale price in Year 1 = C1 = 400
Step 2: Estimate opportunity cost of capital
If equally risky investments in the capital market
offer a return of 7%, then
Cost of capital = r = 7%

Слайд 7

Valuing an Office Building
Step 3: Discount future cash flows
Step 4: Go

ahead if PV of payoff exceeds investment

Слайд 8

Net Present Value

Слайд 9

Risk and Present Value
Higher risk projects require a higher rate of

return
Higher required rates of return cause lower PVs

Слайд 10

Risk and Present Value

Слайд 11

Rate of Return Rule
Accept investments that offer rates of return in

excess of their opportunity cost of capital

Слайд 12

Rate of Return Rule
Accept investments that offer rates of return in

excess of their opportunity cost of capital

Example
In the project listed below, the foregone investment opportunity is 12%. Should we do the project?

Слайд 13

Net Present Value Rule
Accept investments that have positive net present value

Слайд 14

Net Present Value Rule
Accept investments that have positive net present value
Example
Suppose

we can invest $50 today and receive $60 in one year. Should we accept the project given a 10% expected return?

Слайд 15

Opportunity Cost of Capital
Example
You may invest $100,000 today. Depending on the

state of the economy, you may get one of three possible cash payoffs:

Слайд 16

Opportunity Cost of Capital
Example - continued
The stock is trading for $95.65.

Next year’s price, given a normal economy, is forecast at $110

Слайд 17

Opportunity Cost of Capital
Example - continued
The stocks expected payoff leads to

an expected return.

Слайд 18

Opportunity Cost of Capital
Example - continued
Discounting the expected payoff at the

expected return leads to the PV of the project

Слайд 19

Investment vs. Consumption
Some people prefer to consume now. Some prefer to

invest now and consume later. Borrowing and lending allows us to reconcile these opposing desires which may exist within the firm’s shareholders.

Слайд 20

Investment vs. Consumption

Слайд 21

Investment vs. Consumption
The grasshopper (G) wants to consume now. The ant

(A) wants to wait. But each is happy to invest. A prefers to invest 14%, moving up the red arrow, rather than at the 7% interest rate. G invests and then borrows at 7%, thereby transforming $100 into $106.54 of immediate consumption. Because of the investment, G has $114 next year to pay off the loan. The investment’s NPV is $106.54-100 = +6.54

Слайд 22

Investment vs. Consumption
The grasshopper (G) wants to consume now. The ant

100 106.54

Dollars Now

Dollars Later
114
107

A invests $100 now and consumes $114 next year

G invests $100 now, borrows $106.54 and consumes now.

Present Value and The Opportunity Cost of Capital

Содержание

Topics CoveredPresent ValueNet Present ValueNPV RuleROR RuleOpportunity Cost of CapitalManagers and

Present ValuePresent ValueValue today of a future cash flow.Discount RateInterest rate

Present Value

Present ValueDiscount Factor = DF = PV of $1Discount Factors can

Valuing an Office BuildingStep 1: Forecast cash flows Cost of building =

Valuing an Office BuildingStep 3: Discount future cash flowsStep 4: Go

Net Present Value

Risk and Present ValueHigher risk projects require a higher rate of

Risk and Present Value

Rate of Return RuleAccept investments that offer rates of return in

Rate of Return RuleAccept investments that offer rates of return in

Net Present Value RuleAccept investments that have positive net present value

Net Present Value RuleAccept investments that have positive net present valueExample Suppose

Opportunity Cost of CapitalExample You may invest $100,000 today. Depending on the

Opportunity Cost of CapitalExample - continued The stock is trading for $95.65.

Opportunity Cost of CapitalExample - continued The stocks expected payoff leads to

Opportunity Cost of CapitalExample - continued Discounting the expected payoff at the

Investment vs. ConsumptionSome people prefer to consume now. Some prefer to

Investment vs. Consumption

Investment vs. Consumption The grasshopper (G) wants to consume now. The ant

Investment vs. ConsumptionThe grasshopper (G) wants to consume now. The ant

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Topics Covered
Present Value
Net Present Value
NPV Rule
ROR Rule
Opportunity Cost of Capital
Managers and

Present Value
Present Value
Value today of a future cash flow.
Discount Rate
Interest rate

Present Value
Discount Factor = DF = PV of $1
Discount Factors can

Valuing an Office Building
Step 1: Forecast cash flows
Cost of building =

Valuing an Office Building
Step 3: Discount future cash flows
Step 4: Go

Risk and Present Value
Higher risk projects require a higher rate of

Rate of Return Rule
Accept investments that offer rates of return in

Rate of Return Rule
Accept investments that offer rates of return in

Net Present Value Rule
Accept investments that have positive net present value

Net Present Value Rule
Accept investments that have positive net present value
Example
Suppose

Opportunity Cost of Capital
Example
You may invest $100,000 today. Depending on the

Opportunity Cost of Capital
Example - continued
The stock is trading for $95.65.

Opportunity Cost of Capital
Example - continued
The stocks expected payoff leads to

Opportunity Cost of Capital
Example - continued
Discounting the expected payoff at the

Investment vs. Consumption
Some people prefer to consume now. Some prefer to

Investment vs. Consumption
The grasshopper (G) wants to consume now. The ant

Investment vs. Consumption
The grasshopper (G) wants to consume now. The ant