Introduction to Corporate Finance

PART 1: INTRODUCTION

Australis NZ Pty Ltd manufactures tennis racquets

with leased machines. Their leases run for five years,

which corresponds to the useful life of the equipment.

Part of their standard lease agreement dictates that

at the end of the lease, Australis NZ must remove the

old equipment, and fulfilling that requirement costs

Australis NZ about $1,200 per machine. Managers at

Australis NZ want to know the present value of this

cost so that they can add it to the list of up-front fees

that they charge when they sign a new lease with a

client. Assuming that the relevant discount rate is 7%,

what is the present value of a $1,200 payment that

occurs five years in the future?

Substituting FV = $1,200, n = 5, and r = 0.07 into

Equation 3.2 yields the following:

PV^

$1,200

(1 1.07)

$1,200

(1.4026)

= 5 $855.55

+

==

example

Figure 3.3 provides a time line illustrating the cash flows in this example as well as the

calculator and spreadsheet solution methods. The format of Excel’s PV (present value) function is

=pv(rate,nper,pmt,fv,type). The arguments of this function are nearly identical to those of the FV (future

value) function. As before, the arguments ‘pmt’ and ‘type’ apply only to problems with cash-flow streams,

not lump sums, so for those two arguments you enter the value 0. To solve the preceding example using

Excel, you could simply enter =fv(0.07,5,0,–1,200,0), and Excel would provide the answer, $855.55.

Notice that if you enter the $1,200 as a negative number (either in the calculator or the spreadsheet), the

solution for PV comes back as a positive number. In other words, the $1,200 represents an outflow when

FIGURE 3.3 PRESENT VALUE OF $1,700 TO BE RECEIVED IN EIGHT YEARS AT AN 8% DISCOUNT RATE

To calculate the present value of $1,700 received in year 8, we must discount it to reflect the lost opportunity to earn 8%

interest on the money for eight years. In this example, the discounted value of $1,700 equals just $918.46.

0 1 2 3 4 5 6 7 8

End of year FV= $1,700

PV = $918.46

Calculator

Input Function

–1,700 FV

8

8

N

I

CPT

PV

Solution 918.46

Formula B4: =PV(B3,B2,0,B1,0)

Present value $918.46

Interest rate 8%

8

–$1,700

Number of periods

Future value

Row

Column

Spreadsheet

1

2

3

4

5

A B