5- How to Calculate Present Values

the value of money today is worth more than the value tommorow

a higher risk requires a higher return

money earns over time, interest is the cost of borrowing money or revenue of lending money

percentage of interest on principle amount of money borrowed

percentage of interest on principle + interest accumulated
-interest is reinvested

amount to which an investment will grow after earning interest

value today of a future cash flow
- the longer time to maturity, the lower its present value

converting present values to future values

converting future values to present values

FV = PV(1+r)^t

PV = FV/(1+r)^t

DF = 1/(1+r)^t

PV = FV x DF

NPV = FV - C0

NPV = PV + C0

where C0 = initial investment

accept investments that have positive net present value

accept investments that offer rate of return in excess of their opportunity cost of capital R >K

compensates for the risk

what investors expect to recieve over a period of time (investment horizon)

period of time the investor expects to hold the security
- does not equal holding period

period of time the investor holds a security

rate the investor actually receives

expected return is greater than required return

expected return is less than required return

expected rate of return is equal to required

what you give up by investing in one security and therefore not investing in another equally risky security
- equal to the return of equally risk security
- FV are discounted with opportunity cost of capital