CHAPTER 4A Net Present Value: First Principles of Finance
Outline <ul><li>Making Consumption Choices Over Time </li></ul><ul><li>Making Investment Choices Over Time </li></ul><ul><...
Making Consumption Choices over Time <ul><li>An individual can alter his consumption across time periods through borrowing...
Intertemporal Consumption Opportunity Set A person with $95,000 who faces a 10% interest rate has the following opportunit...
Intertemporal Consumption Opportunity Set Another choice available is to consume $60,000 now; invest the remaining $35,000...
Taking Advantage of Our Opportunities A person’s preferences will tend to decide where on the opportunity set they will ch...
Changing Our Opportunities A rise in interest rates will make saving more attractive … … and borrowing less attractive. $0...
Illustrating the Investment Decision <ul><li>Consider an investor who has an initial endowment of income of $40,000 this y...
Illustrating the Investment Decision Our investor begins with the following opportunity set: endowment of $40,000 today, $...
Illustrating the Investment Decision A better alternative would be to invest in the project instead of the financial marke...
Illustrating the Investment Decision Note that we are better off in that we can command more consumption today or next yea...
Upcoming SlideShare
Loading in …5
×

Ross7e ch04appendix

558 views

Published on

Published in: Education
0 Comments
0 Likes
Statistics
Notes
  • Be the first to comment

  • Be the first to like this

No Downloads
Views
Total views
558
On SlideShare
0
From Embeds
0
Number of Embeds
1
Actions
Shares
0
Downloads
20
Comments
0
Likes
0
Embeds 0
No embeds

No notes for slide
  • The point at which the intertemporal opportunity set pivots depends upon where your endowment is when interest rates change. If the person had $95,000 in current consumption and no future consumption, the pivot would have been at the x -axis intercept. Such a pivot
  • Ross7e ch04appendix

    1. 1. CHAPTER 4A Net Present Value: First Principles of Finance
    2. 2. Outline <ul><li>Making Consumption Choices Over Time </li></ul><ul><li>Making Investment Choices Over Time </li></ul><ul><li>Illustrating the Investment Decision </li></ul>
    3. 3. Making Consumption Choices over Time <ul><li>An individual can alter his consumption across time periods through borrowing and lending. </li></ul><ul><li>We can illustrate this by graphing consumption today versus consumption in the future. </li></ul><ul><li>This graph will show intertemporal consumption opportunities. </li></ul>
    4. 4. Intertemporal Consumption Opportunity Set A person with $95,000 who faces a 10% interest rate has the following opportunity set. One choice available is to consume $40,000 now; invest the remaining $55,000; consume $60,500 next year. $0 $20,000 $40,000 $60,000 $80,000 $100,000 $120,000 Consumption today $0 $20,000 $40,000 $60,000 $80,000 $100,000 $120,000 Consumption at t+1
    5. 5. Intertemporal Consumption Opportunity Set Another choice available is to consume $60,000 now; invest the remaining $35,000; consume $38,500 next year . $0 $20,000 $40,000 $60,000 $80,000 $100,000 $120,000 $0 $20,000 $40,000 $60,000 $80,000 $100,000 $120,000 Consumption today Consumption at t+1
    6. 6. Taking Advantage of Our Opportunities A person’s preferences will tend to decide where on the opportunity set they will choose to be. $0 $20,000 $40,000 $60,000 $80,000 $100,000 $120,000 $0 $20,000 $40,000 $60,000 $80,000 $100,000 $120,000 Consumption today Consumption at t+1 Ms. Patience Ms. Impatience
    7. 7. Changing Our Opportunities A rise in interest rates will make saving more attractive … … and borrowing less attractive. $0 $20,000 $40,000 $60,000 $80,000 $100,000 $120,000 $0 $20,000 $40,000 $60,000 $80,000 $100,000 $120,000 Consumption today Consumption at t+1 Consider an investor who has chosen to consume $40,000 now and to consume $60,000 next year.
    8. 8. Illustrating the Investment Decision <ul><li>Consider an investor who has an initial endowment of income of $40,000 this year and $55,000 next year. </li></ul><ul><li>Suppose that he faces a 10-percent interest rate and is offered the following investment. </li></ul>Cash inflows Time Cash outflows 0 1 -$25,000 $30,000
    9. 9. Illustrating the Investment Decision Our investor begins with the following opportunity set: endowment of $40,000 today, $55,000 next year and a 10% interest rate. One choice available is to consume $15,000 now; invest the remaining $25,000 in the financial markets at 10%; consume $82,500 next year. $0 Consumption today $0 $99,000 Consumption at t+1 $90,000 $55,000 $82,500 $40,000 $15,000
    10. 10. Illustrating the Investment Decision A better alternative would be to invest in the project instead of the financial markets. He could consume $15,000 now; invest the remaining $25,000 in the project at 20%; consume $85,000 next year. $0 Consumption today $0 $99,000 Consumption at t+1 $90,000 With borrowing or lending in the financial markets, he can achieve any pattern of cash flows he wants—any of which is better than his original opportunities. $55,000 $82,500 $40,000 $85,000 $15,000
    11. 11. Illustrating the Investment Decision Note that we are better off in that we can command more consumption today or next year. $0 Consumption today $0 $99,000 Consumption at t+1 $101,500 $101,500 = $15,000 ×(1.10) + $85,000 $90,000 $92,273 $55,000 $82,500 $40,000 $85,000 $15,000 $92,273 = $15,000 +

    ×