Discounted Cash Flow Valuation | Corporate Finance | CMA Exam | CPA Exam BEC | Chapter 6

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These lectures cover discounting cash flow valuation, including present value of multiple cash flow, present value of ordinary annuity and present value of single payment.

Future Value of Multiple cash Flow | Corporate Finance

Present Value of Multiple Cash Flows | Corporate Finance

Present Value of Annuities | Corporate Finance

Perpetuity Annuities and Growing Annuities | Corporate Finance

Effective Annual Rate | EAR | Annual Percentage Rate | APR | Corporate Finance

Loan Types | Loan Amortization | Corporate Finance

This chapter rounded out your understanding of fundamental concepts related to the time value of money and discounted cash flow valuation. Several important topics were covered:

  1. There are two ways of calculating present and future values when there are multiple cash flows. Both approaches are straightforward extensions of our earlier analysis of single cash flows.

  2. A series of constant cash flows that arrive or are paid at the end of each period is called an ordinary annuity, and we described some useful shortcuts for determining the present and future values of annuities.

  3. Interest rates can be quoted in a variety of ways. For financial decisions, it is important that any rates being compared be first converted to effective rates. The relationship between a quoted rate, such as an annual percentage rate (APR), and an effective annual rate (EAR) is given by:

    EAR = [1 + (Quoted rate/m)]m − 1

    where m is the number of times during the year the money is compounded or, equivalently, the number of payments during the year.

  4. Many loans are annuities. The process of providing for a loan to be paid off gradually is called amortizing the loan, and we discussed how amortization schedules are prepared and interpreted.

The principles developed in this chapter will figure prominently in the chapters to come. The reason for this is that most investments, whether they involve real assets or financial assets, can be analyzed using the discounted cash flow (DCF) approach. As a result, the DCF approach is broadly applicable and widely used in practice. For example, the next two chapters show how to value bonds and stocks using an extension of the techniques presented in this chapter. Before going on, therefore, you might want to do some of the problems that follow.

This chapter has introduced you to the basic principles of present value and discounted cash flow valuation. In it, we explained a number of things about the time value of money, including these:

  1. For a given rate of return, we can determine the value at some point in the future of an investment made today by calculating the future value of that investment.

  2. We can determine the current worth of a future cash flow or series of cash flows for a given rate of return by calculating the present value of the cash flow(s) involved.

  3. The relationship between present value (PV) and future value (FV) for a given rate r and time t is given by the basic present value equation:

    PV = FVt/(1 + r)t

    As we have shown, it is possible to find any one of the four components (PV, FVtr, or t) given the other three.

The principles developed in this chapter will figure prominently in the chapters to come. The reason for this is that most investments, whether they involve real assets or financial assets, can be analyzed using the discounted cash flow (DCF) approach. As a result, the DCF approach is broadly applicable and widely used in practice. Before going on, therefore, you might want to do some of the problems that follow.