ACST1001 Week 3 Lecture Notes
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Material is for individual research as a Macquarie University student.
Cannot share publicly without permission; Macquarie University holds copyright.
Course: ACST1001 Finance Fundamentals
Focus: Tools for Financial Decision-Making: Time Value of Money.
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Reminder of the same copyright and sharing restrictions as Page 1.
Supportive message for student success with integrity.
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Week 3 Learning Outcomes:
Identify the role of competitive markets in decision-making.
Understand the Valuation Principle for wealth-maximizing decisions.
Assess how interest rates affect present value of future cash flows.
Calculate future and present value of a single cash flow.
Use Excel for calculating cash flow values.
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Week 3 Lecture Outline:
Valuing decisions.
Market prices and valuation principle.
Time value of money and interest rates.
Valuing cash flows at different times.
Excel functions for time value of money.
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Case Study: Tesla's production decision on Cybertruck.
Evaluates how managers assess business decisions.
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Fundamental goal of finance: Maximize wealth through optimal decisions.
Steps in making financial decisions:
Identify relevant costs and benefits.
Convert costs/benefits to common values (e.g., dollars today).
Accept when benefits exceed costs.
Importance of market information and valuation of time.
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Financial managers act on behalf of investors by maximizing firm value.
Challenges in quantifying real-world decisions include using insights from:
Marketing
Economics
Organizational behavior
Strategy
Operations
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Example: Valuing Trade
Using current market prices to establish cash values of silver and gold.
Silver: 400 ounces at $20/ounce = $8,000.
Gold: 5 ounces at $2,000/ounce = $10,000.
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Calculation of net value from the trade:
Benefit = $10,000, Cost = $8,000, Net Value = $10,000 - $8,000 = $2,000.
Positive net value indicates the decision to trade should be accepted.
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Definition of a competitive market:
Goods bought/sold at uniform prices.
Price determines value; uses market prices for evaluation regardless of personal opinions.
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Valuation Principle:
Benefits of a decision should outweigh costs measured via competitive market prices.
When benefits exceed costs, decisions should increase wealth.
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Scenario: Operations manager faces decision to purchase oil and copper for $25,000.
Unsure of necessity; questions the opportunity's value amid market price fluctuations.
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Valuing opportunity using market prices:
Oil: 200 barrels at $90 = $18,000.
Copper: 3,000 kg at $3.50 = $10,500.
Total Value = $18,000 + $10,500 - $25,000 = $3,500 (positive, proceed).
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Importance of current prices; future opinions on commodities irrelevant for today's decision.
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Introduction to Time Value of Money; example of investment:
Cost: $100,000 today; Benefit: $105,000 in one year.
Net calculation needs to account for T.V.M.
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Datasets show cash value transformation into future terms and implications of interest rates:
Interest rate (đť‘ź): the rate for borrowing/lending.
The interest rate factor (1 + r ) is the conversion of today’s dollars to future value through interest factor.
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Future cash reflects discount based on time; the interest rate (đť‘ź) serves as the discount rate.
Discounting is essential to determine prior value from future cash flows.
The discount factor is the value today of a dollar received in the future, expressed as: 1 over (1+r)
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Using interest rate to convert current values to future ones and visa-versa helps evaluate decisions based on the Valuation Principle.
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Future value of the investment if interest is 10%:
Cost today = $100,000, expected growth = $110,000 in a year. Reject investment.
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Benefit in terms of today’s worth:
Future value translated to present value gives insights on investments.
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Net value compares current costs and future benefits.
$95,454.55 present value – $100,000 investment = -$4,545.55 (reject).
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Equivalence conclusion on investment decisions whether using future value or present value calculations.
Present Value (PV) vs Future Value (FV): evaluated against time.
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Timelines as visual tools for cash flow management:
Clearly mark cash flow timings; strong distinctions between inflows and outflows.
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Example of loan and repayment with cash flows illustrated on timeline.
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Rules for comparing and valuing cash flows:
Same timeline comparisons only.
Future values should be compounded.
Present values must be discounted.
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Comparing cash values across distinct time points influences decision-making.
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Demonstrates the growth of cash over time using compounding effects.
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In 20 years, future values include compound interest accumulating on both principal and previous interest.
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Calculation of future values using simple compound interest formulas for clarity.
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Fundamental formula for future value computation with consistency.
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Evaluating between options with future value forecasting emphasized.
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Demonstration that $5,000 today does not surpass $10,000 in future despite immediate availability.
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Discounting principle illustrated based on anticipated future cash flows and equivalent present values.
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General conclusions on present value calculations.
Present value yields insights on prospective financial opportunities.
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Reexamination of Example 1; weighing present value for decisions.
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Confirming calculations show present value advantages for making better financial decisions.
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Excel Functions for time value of money (TVM):
FV function calculates future values of cash flows.
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Revisits the application of Excel's TVM functions in real scenarios.
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PV function in Excel allows users to calculate present values of future cash flows.
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Continues with examples regarding PV calculations using Excel for clearer understanding.
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Summary of concepts covered:
Valuing decisions based on market efficiency.
Time value of money understanding.
Rules for cash flow valuation across different periods.
Excel functions aiding in financial evaluations.
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Formula Review:
Rule 1: Same time comparisons.
Rule 2: Future cash must be compounded.
Rule 3: Cash should be discounted when moving backwards in time.