Chap005Forms - Introduction to Valuation The Time Value of...

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Introduction to Valuation: The Time Value of Money Chapter Five
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Basic Definitions Present Value – earlier money on a time line Future Value – later money on a time line Interest rate – “exchange rate” between earlier money and later money Discount rate Cost of capital Opportunity cost of capital Required return
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Future Values Suppose you invest $1000 for one year at 5% per year. What is the future value in one year? Interest = 1000(.05) = 50 Value in one year = principal + interest = 1000 + 50 = 1050 Future Value (FV) = 1000(1 + .05) = 1050 Suppose you leave the money in for another year. How much will you have two years from now? FV = 1000(1.05)(1.05) = 1000(1.05) 2 = 1102.50
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Future Values: General Formula FV = PV(1 + r) t FV = future value PV = present value r = period interest rate, expressed as a decimal T = number of periods Future value interest factor = (1 + r) t
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Effects of Compounding Simple interest Compound interest Consider the previous example FV with simple interest = 1000 + 50 + 50 = 1100 FV with compound interest = 1102.50 The extra 2.50 comes from the interest of . 05(50) = 2.50 earned on the first interest payment
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Calculator Keys Texas Instruments BA-II Plus FV = future value PV = present value I/Y = period interest rate N = number of periods Remember to clear the registers (CLR TVM) after each problem Other calculators are similar in format
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