Cash flow valuation |
Given the complexity of the problem at hand, you decide to call a financial advisor. He does his research and comes up with the following scenarios: scenario 1: take the money now and invest it at 18% insured rate: $50 million + (.18 x 50 million) = 1.18 x 50 million = 59 million This means if you take the fifty million dollars now you could invest the money at the specified insured rate and get 59 million dollars. If you sign a contract now to wait for a year before you get your money, you will end up with 70 million dollars. Assuming that the economic conditions stays the same and your chance of loosing valuables as a result of the wait is eliminated, then option 2 is your best choice. However, if you stand a chance of loosing your worth as a result of the wait, the situation will be evaluated differently. This method of evaluating a transaction based on what it will be worth in the time to come is called future value (FV) or compound value. Present Value (PV)Present value is the alternative to the approach described above. If say we foresee that the market may not be as good in a year as it is now. Thus we are trying to determine how much money you should be willing to accept and invest now (at the given insured rate)in order to get 70 million by end of the year. This value we are trying to find is what is called the Present value. Otherwise expressed as: PV = C/(1 + r) where C is the cash flow at present, and r is the insured investment interest. Using our example above, your present value can be calculated as follows: PV x 1.18 = $70 million PV = 70 million/1.18 = $59.32 million Thus to beat the offer of $70 million receivable in a year, the potential buyer must give us at least $59.32 million now that we can then invest at 18% insured rate. |
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