1.
Time Value of Money
& Capital Budgeting
Net Present Value
Internal Rate of Return
Payback Period
2.
Time Value of Money
The Time Value of Money addresses the
concept that a dollar is worth more
today than it is at a future point in
time.
This assumption is based on the fact
that often times that dollar can be
invested and be earn more at some point
in time.
3.
Time Value of Money
Present Value
What is the value of a future cash ﬂow TODAY
based on a particular discount (interest) rate ?
Future Value
What is the value of an amount at a particular
time in the future based on a speciﬁed interest
rate?
4.
Present Value
Present Value Formula
Future Cash Flow
Present Value = n
(1 + r)
r = discount (interest) rate
n = number of time periods
5.
Future Value
Future Value Formula
n
Future Value = Original Amount x (1 + r)
r = interest rate
n = number of time periods
6.
Capital Budgeting
Capital Budgeting is used to help plan for capital
expenditures.
The main objective of capital budgeting is to
maximize the value of the ﬁrm.
It is designed to answer:
Which of several mutually exclusive projects should be selected?
How many projects should be selected?
7.
Capital Budgeting
Options:
Payback Period
Net Present Value (NPV)
Internal Rate of Return (IRR)
8.
Template
Use this template for Assignment #4
ONLY enter data in yellow ﬁelds
9.
Cash Flows
Initial Outlay of Cash
For all calculations, enter future cash ﬂows in the “Income
Stream” row for the appropriate year.
Year 0 represents the initial cash outlay for the investment/
purchase.
10.
Payback Period
(Does not consider the TIME VALUE of MONEY)
For Payback period, note when the amount reaches zero in the
“payback period” row.
This will represent the time in which your initial investment was
“paid back.”
Keep in mind: The payback period may fall bet ween years.
Determine in which year the investment will be paid back.
11.
Net Present Value (NPV)
(Considers the TIME VALUE of MONEY)
For Net Present Value, you must know the initial investment,
future cash ﬂows, and the discount rate.
Enter the amounts in the appropriate ﬁelds.
Net Present Value (NPV) is the summation of the Present Values of
all of the future cash ﬂows.
12.
Internal Rate of Return (IRR)
(Considers the TIME VALUE of MONEY)
IRR %
For Internal Rate of Return (IRR), the Net Present Value must be
zero. It is often a guessing game when determining the IRR.
By trial and error, enter % in the IRR ﬁeld. Note what the % does
to the Net Present Value amount. Continue entering percentages
until NPV equals zero (or close to zero).
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