Directions:

Page 110
Double your fun: Recalculate the interest rate using the
back of the evelope calculation in your head and by using
excel.

Example:

Rule of 72:
DOUBLE YOUR FUN
You have been offered an investment that promises to double your m
What is the approximate rate of return on the investm
From the Rule of 72, the rate of return is given approximately by 72/
is approximately 72/10 = 7.2%. Verify that the exact answer is

Helpful Hints:
>Formula, enter rate and number under the rate bar is the
value of years so 10.
> type and guess do not need to be filled out so do not
worry about those

g the
using

N
o double your money every 10 years.
n on the investment?
ximately by 72/r% = 10, so the rate
exact answer is 7.177 percent.

PV
FV
YEARS
RATE

100
200
10
???

Excel Rate
7.18%

Future Value: Multiple Cash

Example 5.1
You think you will be able to depo
at the end of each of the next thr
in a bank account paying 8 perce
interest.
You currently have $7,000 in the
How much will you have in 3 yea
How much in 4 years?

Future Value: Multiple Uneven Cas

Example 5.2 Formulas & Time Line

e Cash Flows

e to deposit $4,000
e next three years
g 8 percent

00 in the account.
in 3 years?

even Cash Flows

ne

DEPOSITS AT END OF EACH OF YRS 1,2,3

RATE
CURRENT VALUE IN ACCOUNT
EXCEL FV IN 3 YEARS
EXCEL FV IN 4 YEARS
AMOUNT IN 3 YEARS W/O INVESTING
AMOUNT IN 4 YEARS W/O INVESTING

End of Yr 1 Deposit
End of Yr 2 Deposit
End of Yr 3 Deposit
Interest Rate
Total Excel FV in 3 years

Total Excel FV in 5 years, if no additional amounts added

5 yr check figure using formula version of calculations

$4,000.00
8%
$7,000.00
$21,803.58
$27,547.87
Err:511
Err:511

Excel FV in 3 years Excel FV in 4 years

$100
$200.00
$300.00

Treasury bills are excellent examples of pure

discount loans.
Principal amount is repaid at some future da
No periodic interest payments
If a T-bill promises to repay $10,000 in 12 mo
and the market interest rate is 7 percent, ho
much will the bill sell for in the market?
1 N; 10,000 FV; 7 I/Y; CPT PV = -9345.79
=PV(.07,1,0,10000)

ples of pure

e future date

00 in 12 months
percent, how
arket?
9345.79

N
FV
R

1
10,000
7
-$1,250.00

Valuing a "Discount" Bond

Par or face value
Coupon Rate
Annual Coupons
Maturity in years
YTM
What is the current market value of the bond? (pv)

$1,000/00
10%
$100.00
5
11%

A technique for determin

value of a particular bond
valuation includes calcul
present value of the bon
interest payments, also k
cash flow, and the bond'
maturity, also known as
or par value.

ue for determining the fair

particular bond. Bond
includes calculating the
alue of the bond's future
ayments, also known as its
and the bond's value upon
also known as its face value
ue.

PREFERRED STOCK
Preferred stock (or preference stock) is
corporation sells preferred stock, the bu
(usually every quarter) forever. This div
to regular stockholders, hence the term
Suppose the Fellini Co. wants to sell pre
preferred stock already outstanding has
every quarter. What dividend will Fellini
The issue that is already out has a prese
forever. Since this is a perpetuity:

To be competitive, the new Fellini issue

the present value is to be $100, the div

rence stock) is an important example of a perpetuity. When a

ed stock, the buyer is promised a fixed cash dividend every period
orever. This dividend must be paid before any dividend can be paid
hence the term preferred.
ants to sell preferred stock at $100 per share. A very similar issue of
outstanding has a price of $40 per share and offers a dividend of $1
dend will Fellini have to offer if the preferred stock is going to sell?
out has a present value of $40 and a cash flow of $1 every quarter
erpetuity:

ew Fellini issue will also have to offer 2.5 percent per quarter; so, if
e $100, the dividend must be such that:

When a
every period
d can be paid

similar issue of
dividend of $1
oing to sell?
every quarter

quarter; so, if

Chapter 7:
Problems 231

#1-7

Question 4
Input Area:

Divident Paid
Dividend Growth Rate
Required Return
Output Area
Price

3.65
5.10%
12%

52.9

Problem 4: pg 232
Stock Values. Nofal Corporation will pay
share dividend next year. The company
increase its dividend by 5.1 percent per
indefinitely. If you require a return of 12
your investment, how much will you pay
company's stock today?

ation will pay a $3.65 per

e company pledges to
percent per year,
return of 12 percent on
will you pay for the

Slide 8-2

CalculatingNPVs with Excel

NPV func on: =NPV(rate,CF01:CFnn)
First parameter =required return entered as a decimal (5%=.05)
Second parameter =range of cash flows beginningwithyear 1

A er compu ngNPV, subtract the ini al investment (CF0)

A

C F
(1 6 5 ,0 0 0 .0 0 )
6 3 ,1 2 0 .0 0
7 0 ,8 0 0 .0 0
9 1 ,0 8 0 .0 0

R e q u ir e d R e tu r n =
F o r m u la
= (- 1 6 5 0 0 0 )/(1 .1 2 ) ^ 0 =
= (6 3 1 2 0 )/( 1 .1 2 )^ 1 =
= (7 0 8 0 0 )/( 1 .1 2 )^ 2 =
= (9 1 0 8 0 )/( 1 .1 2 )^ 3 =

12%
D is c C F s
(1 6 5 ,0 0 0 .0 0 )
5 6 ,3 5 7 .1 4
5 6 ,4 4 1 .3 3
6 4 ,8 2 8 .9 4
1 2 ,6 2 7 .4 1

= N P V (D 2 ,B 5 : B 7 )
NPV + C F0

1 7 7 ,6 2 7 .4 1
1 2 ,6 2 7 .4 1

2
3
4
5
6
7

Y ear
0
1
2
3

9
10
11

EXC EL

8-12

Excel
Capital Budgeting Project

mal (5%=.05)
withyear 1

ment (CF0)

%
C Fs
0 0 0 .0 0 )
3 5 7 .1 4
4 4 1 .3 3
8 2 8 .9 4
6 2 7 .4 1

6 2 7 .4 1
6 2 7 .4 1
8-12

Year

CF
0
1
2
3

Required
Return
62,120.00
70,800.00
91,000.00

Formula Based
NPV
12%
Disc CF's
56,441.33
66,828.94
12,627.4`

mula Based

Slide 8-6

OPEN: Estimating NPV- copy and

paste page 240 section on
estimating NPV including figure 8.1

Present Vale

py and
n
figure 8.1

Estimating Net Present Value

Imagine we are thinking of starting a business to p
estimate the start-up costs with reasonable accura
production. Would this be a good investment? Bas
whether or not the value of the new business exce
investment have a positive NPV?

This problem is much more difficult than our fixer

are not routinely bought and sold in the marketpla
of a similar investment. As a result, we must some
Based on our work in Chapters 4 and 5, you may b
our fertilizer business. We will first try to estimate
We will then apply our basic discounted cash flow
Once we have this estimate, we then estimate NP
cash flows and the cost of the investment. As we m
discounted cash flow, or DCF, valuation.

To see how we might go about estimating NPV, su

business will be $20,000 per year, assuming every
$14,000 per year. We will wind down the business
worth $2,000 as salvage at that time. The project
on new projects such as this one. Is this a good inv
will be the effect on the price per share from takin

From a purely mechanical perspective, we need to

percent. The net cash inflow will be $20,000 cash
cash flows are illustrated in Figure 8.1. As Figure 8
$20,000 14,000 = $6,000 per year along with a
the present value of the future cash flows thus com
Chapter 5. The total present value is:

ue
ting a business to produce and sell a new product, say, organic fertilizer. We can
h reasonable accuracy because we know what we will need to buy to begin
od investment? Based on our discussion, you know that the answer depends on
new business exceeds the cost of starting it. In other words, does this
V?

fficult than our fixer-upper house example, because entire fertilizer companies
old in the marketplace; so it is essentially impossible to observe the market value
sult, we must somehow estimate this value by other means.
4 and 5, you may be able to guess how we will go about estimating the value of
first try to estimate the future cash flows we expect the new business to produce.
counted cash flow procedure to estimate the present value of those cash flows.
e then estimate NPV as the difference between the present value of the future
nvestment. As we mentioned in Chapter 5, this procedure is often called
aluation.

estimating NPV, suppose we believe the cash revenues from our fertilizer
ear, assuming everything goes as expected. Cash costs (including taxes) will be
down the business in eight years. The plant, property, and equipment will be
t time. The project costs $30,000 to launch. We use a 15 percent discount rate
e. Is this a good investment? If there are 1,000 shares of stock outstanding, what
er share from taking the investment?

pective, we need to calculate the present value of the future cash flows at 15
ll be $20,000 cash income less $14,000 in costs per year for eight years. These
ure 8.1. As Figure 8.1 suggests, we effectively have an eight-year annuity of
r year along with a single lump-sum inflow of $2,000 in eight years. Calculating
cash flows thus comes down to the same type of problem we considered in
lue is:

zer. We can
begin
epends on
is

companies
market value

he value of
to produce.
cash flows.
he future
lled

lizer
es) will be
t will be
count rate
anding, what

ws at 15
ars. These
nuity of
Calculating
ered in

Years

Outflow

Inflow

r=

9%

0
1
2
3
4
5

1) Payback period =4 years because the cum CF at year 4=0 so we have recovered all that w
2)NPV
Calculated NPV in Excel
Add: Inniral cash outflow
NPV

3)Excel calculated IPR

4) Reject- we should reject this project because the NPV is negative and the IRR is negative
5) The priary decsion rules should be NPV
6)The IRR

ve recovered all that we have put in

Quick Qu
Q u ic k Q u iz

C h a p te r 8

r =
R eq. P B =

t
0
1
2
3
4
5

C F
( 1 0 0 ,0 0 0 .0 0 )
2 5 ,0 0 0 .0 0
2 5 ,0 0 0 .0 0
2 5 ,0 0 0 .0 0
2 5 ,0 0 0 .0 0
2 5 ,0 0 0 .0 0

C u m u la tv e
C Fs
( 1 0 0 ,0 0 0 .0 0 )
( 7 5 ,0 0 0 .0 0 )
( 5 0 ,0 0 0 .0 0 )
( 2 5 ,0 0 0 .0 0 )
0 .0 0
2 5 ,0 0 0 .0 0

P ayback =

4 y e a rs

N P V =
IR R =

( $ 2 ,7 5 8 .7 2 )
7 .9 3 %

d the IRR is negative

Quick Quiz Solution

C h a p te r 8

=
P B =

9%
4 y rs

0 .0 0 )
0 .0 0
0 .0 0
0 .0 0
0 .0 0
0 .0 0

C u m u la tv e
C Fs
( 1 0 0 ,0 0 0 .0 0 )
( 7 5 ,0 0 0 .0 0 )
( 5 0 ,0 0 0 .0 0 )
( 2 5 ,0 0 0 .0 0 )
0 .0 0
2 5 ,0 0 0 .0 0

ck =

4 y e a rs

=
=

( $ 2 ,7 5 8 .7 2 )
7 .9 3 %

D C F
( 1 0 0 ,0 0 0 .0 0 )
2 2 ,9 3 5 . 7 8
2 1 ,0 4 2 . 0 0
1 9 ,3 0 4 . 5 9
1 7 ,7 1 0 . 6 3
1 6 ,2 4 8 . 2 8
(2 ,7 5 8 .7 2 )

C u m u l a t iv e
D C Fs
( 1 0 0 ,0 0 0 .0 0 )
( 7 7 ,0 6 4 .2 2 )
( 5 6 ,0 2 2 .2 2 )
( 3 6 ,7 1 7 .6 3 )
( 1 9 ,0 0 7 .0 0 )
( 2 ,7 5 8 .7 2 )

= N P V ( E 3 ,C 9 : C 1 3 ) + C 8
= IR R ( C 8 : C 1 3 )

8-69