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:

  1. Valuing decisions.

  2. Market prices and valuation principle.

  3. Time value of money and interest rates.

  4. Valuing cash flows at different times.

  5. 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:

  1. Identify relevant costs and benefits.

  2. Convert costs/benefits to common values (e.g., dollars today).

  3. 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 (𝑟): 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 (𝑟) 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:

  1. Same timeline comparisons only.

  2. Future values should be compounded.

  3. 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.