Summary Financial Decision Making & Law of One Price (CH3)

Running head: FINANCE CH3: FINANCIAL DECISION MAKING & LAW OF ONE PRICE 1




FINANCIAL DECISION MAKING & LAW
OF ONE PRICE

FINANCE CH3




Name
Institution
Course
Tutor
Date

, Finance CH3: Financial Decision Making & Law of One Price 2




Financial Decision Making & Law of One Price



1. VALUING DECISIONS

1.1 ANALYSING COSTS AND BENEFITS

1. step: identifying costs & benefits of a decision

2. step: quantifying those costs & benefits

3. step: evaluating those costs and benefits in the same terms (cash today)



1.2 USING MARKET PRICES TO DETERMINE CASH VALUES

Competitive market: market in which a good can be bought and sold on same
price independent of views and preferences of decision maker

Valuation principle: “Value of an asset to firm or its investors is determined by
its competitive market price. The benefits and costs of a decision should be
evaluated using these market prices, and when the value of the benefits exceeds
the value of the costs, the decision will increase market value of firm”



2. INTEREST RATES & TIME VALUE OF MONEY

• for most financial decisions: costs and benefits occur at different points in time

2.1 TIME VALUE OF MONEY

• one dollar today is worth more than one dollar in a year (eg: could invest it)

Time value of money: difference in value between money today & money in
future