Opportunity Cost of Captial and Present Value

May 23

When it comes time to inform an investment decision, it’s essential to know whether or not a present opportunity represents enough present value to justify the investment. If so, at what level and over what time period. Certainly risk factors in, and with such a broad range of opportunities today, including stock markets, bonds, start ups, etc., there’s a lot to take in to account. The answer to the value and timing of an investment with respect to other available investments is given by the Present Value formula (ref for all equations). where P is the present value C is the anticipated future cash flow r is the interest rate of an alternative investment of similar risk t is the number of investment periods. This may change depending on compounding Another way to look at this is as a cash flow C and a Discount Factor D. where The rate r above is the opportunity cost of captial, or opportunity cost. Note that for multiple cash flows, the equation can be summed  Amount, Time and Risk From an investment perspective, the focus of the above equation is cash flow. More specifically, Amount of cash flow Timing of the cash flow Risk associate with the cash flow All three items factor in to the present value formula, and the present value formula informs many financial decisions, including being the basis for perpetuity and annuity analysis and...

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Five year historical compound rate for MSFT & GOOG

May 18

A review of the stock price and growth rate for Microsoft and Google over the past five years shows that they track very closely in general. However, the last year shows a marked deviation from this tracking as Microsoft stayed mainly flat and Google demonstrated strong growth. Using the data from the source above, we can project the anticipated stock price in 2018 if the growth rate remains constant over that time. Company Stock May 2008 Current Stock Effective Rate Stock May 2018 Google 580.07 909.18 56.74% 1425.05 Microsoft 29.99 34.87 16.27% 40.54 Here are the calculations used to arrive at the effective rates shown above (click to enlarge). Alternate approach In the example above, I calculate the effective rate based on the delta between May, 2008 and May, 2013. Another approach would be to start with the stock price five years ago and use Excel to find the annual rate (assuming annually compounding interest). In this case we get the following details. Company Annual Rate -5Y Today +5Y Google 9.40419% 580.07 909.18 1,425.02 Microsoft 3.0615% 29.99 34.87 40.55 The answers come out the more or less the same, but it helps to know what the annual interest rate is, not just the effective rate over the five year...

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