Present value is the concept that a given amount of money today is worth more than the same amount in the future. The present value of money formulae is a formula used to calculate the present value of a future cash flow or revenue stream with a specific rate of return. The future revenue streams are discounted at the given discount rate with a high discount rate giving a lower current value of the future cash flows. Properly valuing future revenue streams mainly depends on determining a proper discount rate. The formulae for calculating the present value of future cash flows is given as
Present value= (Future value)/ (1+r) n
Where the future value is the future amount one expects to receive at a later date. r, on the other hand, represents the interest rate that one expects to receive between the present time and the future. The exponent n in the denominator represents the period of the future cashflow. For instance, the present value of 1000 to be received in one year with a 10% discount rate would be
Present value=(1000)/ (1+0.1)3=751.31
The cost of capital is the rate of return that could have been earned by putting a similar amount of money into another project with the same amount of risk. It is the opportunity cost of investing in a given project. It can, therefore, be referred to as the required amount of return needed to convince an investor to venture into a project. On the other hand, the cost of equity is the rate of return that a shareholder requires after investing equity in a business. The cost of capital is the return demanded by lenders and owners, while the cost of equity is return demanded by shareholders.
The capital investment process refers to the systematic steps undertaken from the conception of an investment plan down to its completion. It usually starts with project identification, its definition, approval of capital investment, and its ultimate implementation. The capital investment process is important in mitigating the level of risks encountered in the event of an investment.
The after-tax weighted average cost of capital refers to the financial ratio used in the calculation of a company’s cost of financing and acquisition of assets by comparing the debt and equity structure within a firm. It is calculated using the formulae
After-tax WACC =(1-TC)rD(D/V) + rE(E/V) where Tc is the income tax rate, rD is the cost of debt, D/V proportion of debt to total capital, rE the cost of equity and E/V the proportion of equity to total capital. The after-tax weighted average cost of capital aids in evaluating whether a firm should finance its operations through debt or equity by comparing both.
Domestic bond refers to bonds in which issued and traded within a country’s boundaries. It is an obligation of a domestic issue, denominated in the local currency, and traded within the domestic market. An example of a domestic bond is the bonds issued by the Federal Reserve. Foreign bonds, on the other hand, are bonds traded by issuers from a foreign country into the local market. For instance, apple issued yen-denominated bonds in Japan. Finally, the Eurobond bonds are issued by non-residents and are denominated in a currency other than that of the country in which it is placed. An example is the ford motor company issuing a US dollar-denominated bond in Europe.
An operating lease is a contract where an owner, known as the lessor, allows the user, referred to as the lessee, to use an asset for a specific period shorter than the asset’s economic life without transferring ownership rights to the lessee. Examples include plant, machinery, and equipment leases. For instance, instead of buying a widget machine, it may decide to lease it for a lesser amount for a limited period without assuming the risks of ownership, as is the case with buying.
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