Question

Apply present value analysis to determine to make decision and value assets.

Short answer

The present value helps analyze profitable decision makings and the value of perpetual bonds.

Step-by-step solution

Step1:Definition of Present Value

Present value determines the value the person has to invest in order to generate a future amount at a prevailing rate of interest.

Present Value Analysis to make decision:

A project or investment’s net present value equals to the present value of net cash inflows the project is expected to generate, minus the initial capital required for the project.

During the company’s decision-making process, it will use the net present value rule to decide whether to pursue a project, such as an acquisition.

$\mathrm{PV}=\frac{\mathrm{FV}}{{\left(1+\mathrm{i}\right)}^{\mathrm{n}}}$

The person can compute the valuation of the project at the present value through net present value of the project which is simply the difference between the present value of the income stream and the current cost.

$\mathrm{NPV}=\mathrm{PV}-{\mathrm{C}}_{\mathrm{o}}$

If it is positive then the project is profitable and the company will accept the project.

Present Value Analysis to Value assets:

Assets generate cash flows that continue to flow in the economy indefinitely. The present value of the asset can be calculated by

$\begin{array}{rcl}{\mathrm{PV}}_{\mathrm{asset}}& =& \frac{\mathrm{CF}}{\left(1+\mathrm{i}\right)}+\frac{\mathrm{CF}}{{\left(1+\mathrm{i}\right)}^2}+\frac{\mathrm{CF}}{{\left(1+\mathrm{i}\right)}^3}+........\\ & =& \frac{\mathrm{CF}}{\mathrm{i}}\end{array}$

The present value of assets can also be called the present value of perpetuity. It determines the fixed amount that the owner gets at the end of each period.