Time Value & Discounted Cash Flow — Q&A

The time value of money — money today can be invested immediately, so waiting creates opportunity cost (missed returns).

PV = FV ÷ (1 + DR)ⁿ. PV = present value; FV = future cash amount; DR = discount rate (market return/opportunity cost); n = number of years until receipt.

$1,010 ($1,000 + $10 simple interest at 1%). Receiving $1,000 today is more valuable because you earn that $10 while waiting costs you the return.

Year-1 cash flow = $50 (5% × $1,000 par). PV = $50 ÷ 1.06¹ = $47.17.

Year-2 cash flow = $1,050 ($50 coupon + $1,000 par). PV = $1,050 ÷ 1.06² = $1,050 ÷ 1.1236 = $934.50.

$981.67 ($47.17 + $934.50). This benchmarks the bond’s value in today’s dollars against its market price of $970 (quoted at 97).

From a DCF perspective, the bond may be slightly undervalued at its current market price — present value exceeds market price. The comparison of PV to market price is the point of the exercise.

Year 1 pays only the coupon ($50). Year 2 pays the final coupon plus principal repayment ($1,050). Each future payment must be discounted back separately.

The lump sum ($50 million > $42 million annuity PV). DCF/TVM tools compare future payment streams to immediate cash.

The market’s average rate of return — the return you could reasonably earn elsewhere. It captures the opportunity cost of waiting for future cash flows.