Illustration of the Present Value Model under Certainty: Consider P$.$V$.$ Ltd$,$ a one asset firm with no liabilities Assume that the asset will generate end of year cash flows of $$150$ each year for two years and then will have zero value.Assume also the interest rate in the economy is $10$ percent. Then, at time zero $($the beginning of the first year of the assets life$)$ the present value of the firms future cash flows is denoted by PA$0$ is: PA$0=(150/1\mathrm{.}10)+(150/1\mathrm{.}10^2)=136\mathrm{.}36+123\mathrm{.}97=260\mathrm{.}33$we can then prepare a present value$-$opening balance sheet as follows: P$.$V$.$ Ltd$.$Balance SheetTime $0$Capital asset, at present value$$260\mathrm{.}33$Shareholders' equity$$260\mathrm{.}33$The firm's income statement for year $1$ is:P$.$V$.$ Ltd$.$Income StatementFor Year $1$Accretion of discount$$26\mathrm{.}03$Since future net revenues are capitalized into asset value, net income is simply intereston the opening asset value, just as income from a savings account is interest on the opening account balance." Thus, net income for the year is equal to PA

Questions and Problems

Prepare the income statement for year $2$ and the balance sheet at the end of year $2$ for P$.$V$.$ Ltd$.$ in Example $2\mathrm{.}1,$ under the assumption that P$.$V$.$ Ltd$.$ pays no dividends.$*10\%.=260\mathrm{.}33$X $10\%=$ $$26\mathrm{.}03.$ This amount is called accretion of discount. The term arises because the steam of Cash receiptsis one year closer at the end of the year than it was at the beginning.