Professional Documents
Culture Documents
Why TIME?
TIME allows one the opportunity to
postpone consumption and earn INTEREST
NOT having the opportunity to earn interest
on money is called OPPORTUNITY COST
Compound Interest
When interest is paid on not only the principal amount invested, but also on any previous interest
earned, this is called compound interest.
FV = Principal + (Principal x Interest)
= 2000 + (2000 x .06)
= 2000 (1 + i)
= PV (1 + i)
Note: PV refers to Present Value or Principal
6%
$2,000
FV
7
= $2,000 (1.06)2
= $2,247.20
Future Value
(HP 17 B II Calculator)
Exit until you get Fin Menu.
2nd, Clear Data.
Choose Fin, then TVM
2
I%Yr
2000 +/-
PV
FV
2,247.20
8%
$5,000
FV5
10
11
Future Value
(HP 17 B II Calculator)
Exit until you get Fin Menu.
2nd, Clear Data.
Choose Fin, then TVM
5
I%Yr
5000 +/-
PV
FV
7,346.64
12
13
The Rule-of-72
Quick! How long does it take to double
$5,000 at a compound rate of 12% per
year (approx.)?
Approx. Years to Double = 72 / i%
72 / 12% = 6 Years
[Actual Time is 6.12 Years]
14
Present Value
Since FV = PV(1 + i)n.
PV = FV / (1+i)n.
Discounting is the process of translating a
future value or a set of future cash flows
into a present value.
15
6%
10
$4,000
PV0
16
Present Value
(HP 17 B II Calculator)
Exit until you get Fin Menu.
2nd, Clear Data.
Choose Fin, then TVM
10
I%Yr
4000
FV
PV
-2,233.57
18
4%
5
$2,500
PV0
19
20
Present Value
(HP 17 B II Calculator)
Exit until you get Fin Menu.
2nd, Clear Data.
Choose Fin, then TVM
I%Yr
2,500 +/-
FV
PV
2,054.81
21
22
(HP 17 B II Calculator)
Exit until you get Fin Menu.
2nd, Clear Data.
Choose Fin, then TVM
5
2000 +/-
PV
2,676.45
FV
I%Yr
6.00
23
Frequency of Compounding
General Formula:
FVn = PV0(1 + [i/m])mn
n: Number of Years
m: Compounding Periods per Year
i: Annual Interest Rate
FVn,m: FV at the end of Year n
PV0:
Effects of Multiple
Compounding Periods
General equation: PVn = FV (1 + i/m)nm
Example with semiannual compounding
Multiply years by 2 to get total periods.
Divide discount rate by 2 to get periodic rate.
Divide annual payment by 2 to get periodic pmt.
Frequency of Compounding
Example
Suppose you deposit $1,000 in an account that
pays 12% interest, compounded quarterly. How
much will be in the account after eight years if
there are no withdrawals?
PV = $1,000
i = 12%/4 = 3% per quarter
n = 8 x 4 = 32 quarters
26
27
I%Yr
1000 +/-
PV
FV
2,575.10
28
Annuities
Example of an Ordinary
Annuity -- FVA
0
End of Year
7%
$1,000
$1,000
$1,000
$1,070
$1,145
$3,215 = FVA3
30
Future Value
(HP 17 B II Calculator)
Exit until you get Fin Menu.
2nd, Clear Data.
Choose Fin, then TVM
1,000 +/-
PMT
I%Yr
FV
3,214.90
31
Example of an Ordinary
Annuity -- PVA
0
End of Year
7%
$1,000
$1,000
$1,000
$934.58
$873.44
$816.30
$2,624.32 = PVA3
Present Value
(HP 17 B II Calculator)
Exit until you get Fin Menu.
2nd, Clear Data.
Choose Fin, then TVM
1,000
PMT
I% Yr
PV
-2,624.32
33
5%
$500
$600 $10,700
PV0
34
5%
$500
$600 $10,700
$476.19
$544.22
$9,243.06
CFLO
Flow(0)=?
Input
Flow(1)=?
500
Input
# Times (1) = 1
Input
Flow(2)=?
600
Input
# Times (2) = 1
Input
Flow(3)=?
10,700
Input
Exit
Calc
5
I%
NPV
36
FIN
TVM
30
PMT
1000
FV
I% YR
20
PV
-864.09
30
30
20
30
1000
38
Problem #1
You must decide between $25,000 in cash
today or $30,000 in cash to be received two
years from now. If you can earn 8% interest
on your investments, which is the better
deal?
39
Need a Hint?
40
I%YR
30,000
FV
PV
-25,720.16
Problem #2
What is the value of $100 per year for four
years, with the first cash flow one year from
today, if one is earning 5% interest,
compounded annually? Find the value of
these cash flows four years from today.
42
Need a
Hint?
43
100
PMT
I% YR
FV
431.01
100
100
100
100
44
Problem #3
What is todays value of a $1,000 face value
bond with a 5% coupon rate (interest is paid
semi-annually) which has three years
remaining to maturity. The bond is priced
to yield 8%.
45
Need a hint?
46
FIN
TVM
25
PMT
1000
FV
I% YR
PV
921.37
25
25
12
25
1000
47
Congratulations!
You obviously understand this material!!
48
Comparing PV to FV
Remember, both quantities must be present
value amounts or both quantities must be
future value amounts in order to be
compared.
49
Valuing a Bond
The interest payments represent an annuity and
you must find the present value of the annuity.
The maturity value represents a future value
amount and you must find the present value of this
single amount.
Since the interest is paid semi-annually, discount at
HALF the required rate of return (4%) and TWICE
the number of years to maturity (6 periods).
51
Applications of Present
Value Techniques
Deposits to accumulate a future sum
Useful for calculating a childs education fund, a
retirement fund, etc.
Once you know the sum you wish to save, the
formula is:
PMT = [FVAn / FVIFAi,n]
0.0067
1
1(1.0067) 360
$1473.11
53
54
= 360
PV
= ($100,000)
FV
= $0
= 9%
55
Application: Accumulating a
Future Sum
An individual would like to purchase a
home in five (5) years. The individual will
accumulate enough money for a $20,000
down payment by making equal monthly
payments to an account that is expected to
earn 12% annual interest compounded
monthly. How much are the equal monthly
payments?
56
Application: Accumulating a
Future Sum
In the previous example, our saver
deposited
$244.89 x 60 = $14,693.40
Interest Earned was
$20,000 - $14,693.40 = $5,306.60
57
58
= 15
FV
= $0
=7
PMT
= $10979.46
59
Present Value of a
Growing Annuity
Algebraic solution
1 g
1n
1 i
PVAn = PMT0 1 g
i - g
61
Application: Value of
Gold Mine
You have rights to mine for 20 years, expecting to extract
5,000 ounces of gold every year. The price per ounce is
currently $300, but is increasing at 3% per year. The
appropriate discount rate is 10%.
1.03 20
1
20
1.10
PV0 = $300 5,000 1.03
0.10 0.03
$16,145,980
62