FIN notes 2 - Time Value of Money The value of any...

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Time Value of Money02/10/2016°The value of any asset (investment) is determined by:1. Return – the benefit from investing current income vs. capital gains income2. Time – how long you will have to wait to receive the return3. Risk – the chance that you will not receive the expected return°°1. Future Value of a Lump sum (a single deposit)FVIF: Future Value Interest Factor (D-1)Present Value --- Future Value “compounding over time”Ex: You invest $3000 into an account earning 5%. After 5 years what has the account grown to?FV=PV(FVIF)o=3000(D-1,5%,5=1.276) = $3828°°*The “Rule of 72” shows how long it takes to double your money72 / interest rate = number of years needed to double your money72 / number of years = annual interest rate earned°Ex: You invest $5000 at 8%, how long will it take to double your money?72/8 = 9 years°Ex: If your investment doubled in 6 years, what annual interest rate were you earning?72/6 = 12%°
FVIFA: Future Value Interest Factor of an Annuity (D-2)°Ex: You invest $5000 annually into your Roth IRA which is earning 8% annually. After 35 years, what is the balance of your IRA?
3. Sinking Fund (FVIFA)deposits that are needed to accumulate a future amount°Ex: You are planning on retiring in 40 years and you would like to save an additional $2,500,000 in addition to your retirement savings. How much will you need to SAVE ANNUALLY– earning 8% interest – in order to reach your goal?
4. Present Value of a Lump SumWhat is a future benefit worth to you today?PVIF: Present Value Interest FactorPresent Value  Future Value (discounting over time)°Ex: You have just won a $2,000,000 court settlement which will be paidto you in 10 yrs. IN other words, you won’t receive anything until the end of the 10thyear. Assuming 7% interest, what is your settlement worth to you TODAY?

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