Understanding Time Value of Money

• Future cash flows need to be discounted to present value for accurate comparisons.
• Net Present Value (NPV) helps evaluate different cash flow options by considering the time value of money.

Lottery Examples and Options

• Lottery winnings may be presented as either lump sum or an annuity payment over years (e.g. $1 million over 30 years).
• Options for payout:
• Option 1: Lump sum today, e.g., $300,000.
• Option 2: $20,000 annually for 30 years.
• Option 3: $30,000 annually for 15 years.
• Option 4: $100,000 today plus $15,000 annually for 30 years.
• Option 5: $1 million after 30 years.

Choosing Between Lump Sum and Annuity

• Factors influencing choice:
• Immediate cash versus future cash.
• Consider inflation rates and investment opportunities.
• Immediate needs vs. long-term investment strategy.

Using Excel for Financial Models

• Create spreadsheets to evaluate cash flows over time; important for analysis and decision-making.
• Essential to format cash flow data correctly (currency, decimals).

Calculating Present Value and NPV

• NPV = Present value of future cash flows - Initial investment.
• Discount Rate: Must be established before calculating NPV; reflects opportunity cost and risk associated with cash flows.
• Example: A 5% discount rate based on expected returns from a low-risk investment.

Setting Up NPV Calculation in Excel

• Use the NPV function:
• Syntax: =NPV(discount_rate, value1, [value2], ...)
• Remember to include initial cash outlays separately, as NPV only considers future cash flows from the formula.

Comparison of Options

• Calculate NPVs for each option under varying discount rates to value options correctly.
• Higher rates decrease present value of future cash flows, affecting which option may seem most valuable today.

Importance of Financial Models

• Helps visualize effects of choices on future cash returns.
• Allows for adjustment based on new information (e.g., changes in discount rate).

Additional Considerations

• Possible tax implications of lump sum vs. annuity payments (how much will be lost to taxation).
• Consult a financial advisor for detailed analysis tailored to personal situation.

Practical Skills in Excel

• Ability to build models to forecast and analyze financial outcomes.
• Understanding database functions and data validation to maintain data integrity in analyses.