CASH FLOW VALUATIONS

Means that at the end of every time

period the cash flow level or cash flow
amount is different.

Example:
An investment returns 10000 after first
year, 13000, 15000 & 18000 after 2nd to
4th year respectively. If the prevailing
interest is 10% what is the present value
of cash flow.

Equations:
FV = PV x (1 + r)t
PV = FV [ 1 / (1 + r)t ]

YEAR
1

CASH
FLOW
10000

FVIF @
= 1.10

9,090.91

13000

= 1.21

10,743.80

15000

= 1.331

11,269.72

18000

= 1.4641

12,294.24

TOTAL

56000

10%

PV=
Cash Flow / FVIF

43,398.68

Effective Annual Rate EAR

EAR basically depend on

Compounding
More period of Compounding total
interest
will be more

Effective Annual Rate EA

Example:
Bank A pays 15% interest on deposit,
that is compounded monthly.
Bank B pays 15% interest on deposit,
which is compounded quarterly.
Bank C pays 15% interest on deposit,
which is compounded half yearly.

Formula to find EAR

Bank A (Monthly Compounding)
EAR = 1 + i/n n

-1

Bank A = 1 + .15/12 12 - 1
=1.16075 1
= 16.075%

 Bank B (Quarterly Compounding)

Bank B = 1 + .15/4 4 - 1
=(1.0375) 4 1
= 1.15865 1
= 15.865%

Bank C (Half Yearly Compounding)

Bank C = (1 + .15/2) 2 - 1
= (1.075) 2 - 1
= 1.155625 1
= 15.5625%

Example:
A bank offers 12% compounded quarterly.
If you place 1000 in an account today, how
much you have at the end of two years?
What is EAR (Effective Rate of Interest)?

Solution:
EAR =(1 + i/n)n - 1
EAR = (1 + .12/4)4 1= 12.55%
= (1.1255)2 X 1000 = 1266.75

OR
Quarterly interest is 12/4 = 3%
=(1.03)8 X 1000 = 1.2667 X 1000
=1266.77

BOND VALUATION
Its a debt security
Whenever Company needs Capital,
different sources to raise Capital
IPOs of Shares in Primary Market
Bank Loan
Bond Debt Financing (Different from
bank loan)

Bonds have maturity date

Normally Bonds are Long Term like 10
years, 20 years & 30 years

Main Characteristics:

How much Interest will be paid?

How many times?
Maturity

Terminologies:

Coupon Payments: stated annual

interest amount
e.g. A Bond which pays Rs. 100 every
year. So Coupon payment i.e. Rs. 100 per
year.
Coupon Rate:
Coupon Interest Rate = Interest /
Investment
Face value: Also Par value, shows the
nomination value.

 Maturity Date: date on which Companies

pay back the principal Investment.
Discount Bond: A bond which is sold less
than the face or par value is discount
bond. Also called Zero Coupon Or Zeros.
Premium Bond: A bond which has a
price over and above its face value or its
par value is Premium Bond.
Yield to Maturity (YTM): Interest rate
required in market on a bond.
Or
A Market phenomenon, Interest rate on
particular Investment
Current yield: Annual coupon payment(s)
divided by bond price.