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Discounted Cash Flow

Financial Management

Team 1: Simone (R66084106), Ting (R66084059),

Petty (R66097010), Tri (R66097214), Michelina (R66087031)
Agenda 01 Present and Future Value
Simone (R66084106)

02 Compounding Periods
Ting (R66084059)

03 Perpetuity
Petty (R66097010)

04 Annuity
Tri (R66097214)

05 Loan and Firm Evaluation

Michelina (R66087031)
Present Value
and Future Value
 Present Value and Future Value

$=? r 10% interest rate $ 1000

for 8 years
Future Value
n

PV 𝑛 FV = C
PV = FV / (1 + r)

FV = PV * (1 + r)𝑛
 Net Present Value

NPV > 0
rate of return >
Cost of opportunity cost of
investment capital (discount rate)

𝑛
NPV = C0 + C1* (1/1+r) NPV = 0
rate of return =
If initial investment is $430 opportunity cost of
capital
 PV = 466
 NPV = - 430 + 466 = $ 24 NPV < 0
rate of return <
opportunity cost of
capital
 Simple Interest and Compound Interest

Principal : $ 10,000

Ben Claire

Simple Interest Compound Interest

 Simple Interest and Compound Interest

5 % on principal 5 % on principal
= 10,000 x 0.05 = 10,000 x 0.05
Year 1

Ben Claire
Annual Return on Investment
Simple Interest Compound Interes
Ben Claire
Year 1 $ 500 $ 500
 Simple Interest and Compound Interest

5 % on only principal &

5 % on only principal accumulated interest
=10,000 x 0.05 = (10,000 + 500) x 0.05
= $500 Year 2 = 525

Ben Claire
Annual Return on Investment
Simple Interest Compound Interes
Ben Claire
Year 1 $500 $ 500
Year 2 $500 $ 525
 Simple Interest and Compound Interest
Annual Return on Investment
Ben Claire Claire
(Year n - 10 Year
Year 1) Annual Return on Investment
Year 1 $500 $ 500 0 $900
$800
Year 2 $500 $ 525 25
$700
Year 3 $500 $551.25 51.25 $600

Year 4 $500 $578.81 78.81 $500

$400
Year 5 $500 $607.05 107.05 $300
Year 6 $500 $638.14 138.14 $200
$100
Year 7 $500 $670.05 170.05
$0
Year 8 $500 $703.55 203.55 1 2 3 4 5 6 7 8 9 10

Year 9 $500 $738.73 238.73 Ben Claire

Year 10 $500 $775.66 275.66
 Questions

The longer-lasting the loan, the important “interest on interest” become?

A: Yes.

Which interest receiving from the bank deposit will be higher, simple or compound?

A: Compound interest.
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Compounding
Periods
 Compounding Period
i ii iii iv v
Periods Interest Value Annually
per per APR after compounded
year period (i x ii) one year interest rate

1 6% 6% 1.06 6.000%
2 3 6 1.032 = 1.0609 6.090
4 1.5 6 1.0154 = 1.06136 6.136

12 .5 6 1.00512 = 1.06168 6.168

52 .1154 6 1.00115452 = 1.06180 6.180
365 .0164 6 1.000164365 = 1.06183 6.183
 Annual Percentage Rate & Effective Annual Rate
The effective annual interest rate is the
The term “annual percentage rate real return on a savings account or any
(APR)” refers to the annual rate of interest-paying investment when the
interest charged to borrowers and effects of compounding over time are
paid to investors. taken into account.

𝑟 𝑚
𝑐0 1+ 𝑚
𝑚 𝑟
APR EAR 1+ −1
C0 = Initial Investment 𝑚
r = Annual Percentage Rate
m = Compounding Period

EAR
APR Effective Annual Rate based
Annual Percentage Rate on Compounding Interest
based on Simple Interest
 Annual Percentage Rate & Effective Annual Rate
• Invest $100 in certificate of deposit, offering 5% annual rate with
semi-annual compounding. How much money will you have in one
year?

• Annual Percentage Rate = 5%

• Effective Annual Rate =

𝑚 2
𝑟 0.05
1+ −1= 1+ −1= 5.0625%
𝑚 2
 Compounding over Many Years
$100 investment at 5% annual rate,
compounded semi-annually, for 5
Future Value with Compounding years.

𝑟 𝑚𝑡 2×5
FV = 𝐶0 1 + 0.05
𝑚 $100 × 1 +
2
C0 = Initial Investment $100 × 1.02510
r = Annual Percentage Rate
$100 × 1.28
m = Compounding Period
t = Years $128
 Question
1. Is EAR is greater than APR in general ?
Yes
2. The samller the interest per period is, the greater the
value in specific period will be.
Yes
Perpetuity
Perpetuity
Perpetuity is a constant stream of cash flows without end
Perpetuity
What is the present value of a perpetual What is the present value of a perpetual
bond if the payment is $50 a year and the bond if the payment is $50 a year but the
interest rate is 5%? interest rate is 2%?

$50 $50
PV = = $1,000 PV = = $2,500
0.05 0.02

Interest Rate ↑, The Value of The Perpetuity↓

Growing Perpetuity
Growing perpetuity is the stream of cash flow that will continuously
rise indefinitely

𝐶
PV = Three important points concerning the growing
𝑟−𝑔 perpetuity formula:

C = Cash flow 1. The numerator

r = Discount rate 2. The discount rate and the growth rate
3. The timing assumption
g = Growth rate
 Annuity

Annuity - An asset that pays a fixed

sum each year for a specified
number of years.
 Example
(given the interest: 2%/month)

Option 1: Your parents will give you 20.000NTD

every month for two years (24 months)

Option 2: Your parents will give you 40.000NTD

every month since your second year (12 months)

Option 3: Your parents will give you 400.000NTD immediately

Decision making 01 Comparing present value

process
02 Use excel to save your time
(using npv function)

03 Choose the highest value

 Example
(given the interest: 2%/month)

Option 1 Option 2 Option 3

#379k NTD #423kNTD 400k NTD

 Example
(given the interest: 3%/month)

Option 1 Option 2 Option 3

#339k NTD #398kNTD 400k NTD

 01 Know how to use excel
Take-away

02 Pay deep attention to

the interest

03 Make the right decision

Loans
Pure Discount Loans, Interest only Loans,
Amortized Loans
Pay interest as the length of the loan

Pure discount loans

Example 1

5 years

5%
Mr. C
$1,000,000

How much Mr. Chang need to pay back after 5 years?

 Answer
$1,000,000 x (1.05)5 =
1,187,272
Example 2

5 years
$3,000,000 Mr. C
5%

How much is the net present value?

 Answer
$3,000,000 / (1.05)5 =
2,350,578
 Repay the entire debt at some
Pay interest each period
point in the future

Interest only loans

Example 1

5 years
5%
Mr. C
$1,000,000

How much Mr. Chang need to pay?

 $1,000,000 x 0.05 =
$15,000/year

After 5 years

$1,000,000 + $15,000 =
$1,015,000
Repay part of the loan overtime.

Amortized loans
Example 1

3 years

Mr. C 5%
$3,000,000 $1,000,000

How much Mr. Chang need to pay?

 How much does Mr.
Chang need to pay in the
first month?
Answer
$1,000,000 + ($3,000,000 x 0.05) =
$1,150,000

Ending balance?
$3,000,000 - $1,000,000 =
$2,000,000
 How much does Mr.
Chang need to pay in the
second month?
Answer
$1,000,000 + ($2,000,000 x 0.05) =
$1,100,000

Ending balance?
$2,000,000 - $1,000,000 =
$1,000,000
 How much does Mr.
Chang need to pay in the
last month?
Answer
$1,000,000 + ($1,000,000 x 0.05) =
$1,050,000

Ending balance?
$1,000,000 - $1,000,000 =
$0
 Discussion!

Cookies me up!
Revenue: NTD 100,000

What type of loan will you take and why?

Firm Worth
 Example

Cookies me up!
Revenue: NTD 100,000
Age: 5 years
Profit: 10%

Calculate the net present value!

 Cookies me up net cash flow

End of Present value of the firm

year Net cash flow Present value factor Present value of cash flow
1 $5,000 0.91 $4,550
2 $2,000 0.83 $1,660
3 $2,000 0.75 $1,500
4 $2,000 0.68 $1,360
5 $7,000 0.62 $4,340

Present value of firm $13,410

 Simplifying formula

$𝟓,𝟎𝟎𝟎 $𝟐,𝟎𝟎𝟎∗𝑷𝑽𝑰𝑭𝑨𝟏𝟎%,𝟑 $𝟕,𝟎𝟎𝟎

+ + = $13,410
𝟏.𝟏 𝟏.𝟏 𝟏.𝟏𝟓

1
1−
= 1.13
0.1
= 2.49
 Supposed you want to buy the company for
$15,000. Should you buy the firm? WHY?

Present value – Cost = Net present Value

$13,410 - $15,000 = -$1,590

Since you will have a decremental value of $1,590

THANK YOU
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