What would 150m be worth at the end of 5 years if invested at 7%?
Interest rate 8% Year 0 1 2 3 4 5 Today's value 150 150 150 150 150 150 Multiplication factor = (1+interest rate)^year 1.00 1.08 1.17 1.26 1.36 1.47 Value at end of period (future value) 150.00 162.00 174.96 188.96 204.07 220.40 Answer: value at end of period = 220.40 Note, Excel formula check: 220.40 Formula for compound interest Exercise 2 - introducing time value of money & discount factors Cost of funds 8% Year 0 1 2 3 4 Future value 200 200 200 200 200 Discount factor = 1/(1+interest rate)^year 1.00 0.93 0.86 0.79 0.74 Today's value (present value) 200.00 185.19 171.47 158.77 147.01 Answer: present value = 147.01 Note, Excel formula check: 147.01 Formula for discounting ( = 1 / compound interest) Exercise 3 - discounted cash flows Cost of funds 12% Year 0 1 2 3 4 5 Future value 0 10 10 10 10 10 Discount factor = 1/(1+interest rate)^year 1.00 0.89 0.80 0.71 0.64 0.57 Present value 0.00 8.93 7.97 7.12 6.36 5.67 Answer: present value ( = sum of discounted cash flows) = 36.05 Note, Excel formula check: 36.05 Formula for NPV If I had a contract that paid out 10m per year for 5 years, and my cost of funds (or cost of capital) was 12%, what would that contract be worth to me today? If I had to pay back 200m in four years' time, and I anticipated interest rates of 8%, how much money would I have to set aside today? 239272472.xls.ms_office Page 1 of 6 Exercise 4 - discounted cash flows (a) Cost of funds 9% Year 0 1 2 3 4 Future value 0 10 20 15 8 Discount factor 1.00 0.92 0.84 0.77 0.71 Present value 0.00 9.17 16.83 11.58 5.67 Answer: present value = 43.26 Note, Excel formula check: 43.26 Formula for NPV Exercise 5 - net present value If I paid 30m for the business above, what would the net present value of the investment be? Cost of funds 9% Year 0 1 2 3 4 Future value -30 10 20 15 8 Discount factor 1.00 0.92 0.84 0.77 0.71 Present value -30.00 9.17 16.83 11.58 5.67 Answer: net present value = 13.26 Check: present value of cash flows 43.26 Formula for NPV Price paid -30.00 Price paid Answer: net present value of investment = 13.26 NPV Note, how to get it wrong using Excel: 12.16 Why do you think this happens in Excel? Exercise 6 - net present value (a) Cost of funds 14% Year 0 1 2 3 Future value -40 20 26 34 Discount factor 1.00 0.88 0.77 0.67 Present value -40.00 17.54 20.01 22.95 Answer: net present value = 20.50 Check: present value of cash flows 60.50 Formula for NPV Price paid -40.00 Price paid Answer: net present value of investment = 20.50 NPV If I paid 40m for a business that was expected to generate the cash flow stream below, and my cost of capital was 14%, what would I expect the NPV of the investment to be? If I had a business that generated the cash flow stream below, and my cost of capital was 9%, what would I be prepared to pay for that business? 239272472.xls.ms_office Page 2 of 6 Exercise 7 - IRR What would my IRR on the investment be (= discount rate where NPV = zero)? Answer: IRR (= discount rate) = 40% Iterate and change cost of funds until NPV = zero Year 0 1 2 3 Future value -40 20 26 34 Discount factor = 1/(1+interest rate)^year 1.00 0.71 0.51 0.37 Present value -40.00 14.30 13.29 12.42 Net present value = 0.00 Note, Excel formula check: 40% Formula for IRR Exercise 8 - IRR (a) - semi-annual cash flows What would my IRR on the investment be if the cash flows above were actually received at six monthly rather than annual intervals? Answer: IRR (= discount rate) = 96% Iterate and change cost of funds until NPV = zero Period 0 0.5 1 1.5 Future value -40 20 26 34 Discount factor = 1/(1+interest rate)^year 1.00 0.71 0.51 0.37 Present value -40.00 14.30 13.29 12.42 Net present value = 0.00 Note, Excel formula check: ??? One reason to avoid the IRR formula! Exercise 9 - IRR (b) If a private equity firm put 20m into an investment and generated sales proceeds of 60m after three years, what was its IRR? Answer: IRR (= discount rate) = 44% Iterate and change cost of funds until NPV = zero Year 0 1 2 3 Future value -20 0 0 60 Discount factor 1.00 0.69 0.48 0.33 Present value -20.00 0.00 0.00 20.00 Net present value of investment = 0.00 Note, Excel formula check: 44% IRR formula 239272472.xls.ms_office Page 3 of 6 Answer 1 - compound interest Correct answer: what would 10m be worth at the end of 3 years if invested at 8%? Interest rate 8% Year 0 1 2 3 Today's value 10 10 10 10 Multiplication factor = (1+interest rate)^year 1.00 1.08 1.17 1.26 Value at end of period (future value) 10.00 10.80 11.66 12.60 Answer: value at end of period = 12.60 Note, Excel formula check: 12.60 Formula for compound interest Wrong answer 1 10.80 Wrong answer 2 11.66 Wrong answer 3 12.40 Wrong answer 4 13.60 Answer 2 - compound growth rate Correct answer 24.57% Wrong answer 1 11.11% Wrong answer 2 22.22% Wrong answer 3 33.33% Wrong answer 4 66.67% Answer 5 - NPV 1 2 3 4 5 Cost of funds 8% 10.0 10.0 10.0 10.0 10.0 DCF 39.9 9.3 8.6 7.9 7.4 6.8 Cost (35.0) NPV 4.9 Check 4.9 Wrong answer 1 4.6 Wrong answer 2 8.1 Answer 6 - IRR Wrong answer Column B Column C Column D Column E Column F Column G Y1 Y2 Y3 Y4 Y5 Row 3 (20) 0 0 0 60 31.61% Right answer Y0 Y1 Y2 Y3 Y4 Y5 Row 7 (20) 0 0 0 0 60 24.57% Wrong answer Y1 Y2 Y3 Y4 Y5 Row 11 (20) 60 200.00% Wrong answer Y0 Y5 Row 15 (20) 60 200.00% 239272472.xls.ms_office Page 4 of 6 Answer 7 - IRR with semi-annual cash flows 0.5 1.0 1.5 2.0 2.5 3.0 Cost of funds 42% 50.0 200.0 DCF 100.0 0.0 0.0 29.7 0.0 0.0 70.3 Cost (100.0) NPV 0.0 Wrong answer 1 19% (100) 0 0 50 0 0 200 Wrong answer 2 24% (100) 0 50 0 0 200 0 Wrong answer 3 34% (100) 50 0 0 200 Wrong answer 4 69% (100) 50 200 Answer 8 - XIRR 27-Jun-08 15-Mar-11 IRR = 81% (1.0) 5.0 Years = 2.7 239272472.xls.ms_office Page 5 of 6 Method (i): NPV = 0 What would my IRR on the investment be (= discount rate where NPV = zero)? Answer: IRR (= discount rate) = 24.57% Iterate and change cost of funds until NPV = zero Year 0 1 2 3 4 5 Future value -20 0 0 0 0 60 Discount factor = 1/(1+interest rate)^year 1.00 0.80 0.64 0.52 0.42 0.33 Present value -20.00 0.00 0.00 0.00 0.00 20.00 Net present value = 0.00 Method (ii): Algebra Algebra: 24.57% Method (iii): IRR formula IRR formula: 24.57% Formula for IRR 239272472.xls.ms_office Page 6 of 6