FinStatementsTaxesCashFlow_Notes

FinStatementsTaxesCashFlow_Notes - Introduction to...

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Introduction to Valuation: The time value of money BUAD 306 - Spring 2009 Jesus Sierra Department of Finance and Business Economics Marshall School of Business University of Southern California January 19, 2009 Jesus Sierra (USC-FBE) January 19, 2009 1 / 38
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Key concepts and skills Be able to compute the future value of an investment made today Be able to compute the present value of cash to be received at some future date Be able to compute the return on an investment Be able to compute the number of periods that equates a present value and a future value given an interest rate Be able to use tables or a calculator to solve time value of money problems Jesus Sierra (USC-FBE) January 19, 2009 2 / 38
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Outline Future Value and Com pounding Present Value and Dis counting More on Present and Future Values Jesus Sierra (USC-FBE) January 19, 2009 3 / 38
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Present Value What is more valuable: 1 $100 to be received today, or 2 $100 to be received in 10 years ? Jesus Sierra (USC-FBE) January 19, 2009 4 / 38
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Time value of money Clearly, option 1 is more valuable, since if you were given the money today, you could invest it in the bank and earn interest . The phrase time value of money refers to the fact that a dollar today is worth more than a dollar promised at some time in the future. Jesus Sierra (USC-FBE) January 19, 2009 5 / 38
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Future Value(FV) and Compounding Future Value(FV) is the amount of money your investment will grow to, over some period of time, at some given interest rate. Suppose you go to Bank of America and deposit $100 in a savings account that pays you 10% annual interest. In one year, how much will you have ? Jesus Sierra (USC-FBE) January 19, 2009 6 / 38
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Future Value(FV) and Compounding You will have 100 × (1 . 10) = $110 dollars: this is the Future value . Of these, $100 is just the initial amount you invested which the bank now returns to you. This is called the principal . The rest, 100 × (0 . 10) = $10 is the interest you earned. Then, we say that $100 today is worth $110 in one year, given that the interest rate is 10%. In general, when interest rates are positive, $100 today is NOT the same as $100 in a year. Jesus Sierra (USC-FBE) January 19, 2009 7 / 38
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Future Value(FV) and Compounding What if you invest for two years? In this case, at the end of the second year, you will have 100 × (1 . 10) × (1 . 10) = $121 dollars. This is the FV . This return can be broken down into 4 parts: 1 Again, $100 is the principal . 2 100 × (0 . 10) = $10 is the simple interest you earn in the first year. 3 100 × (0 . 10) = $10 is the simple interest you earn in the second year. In total, you earn $20 in interest. 4 But now, there is an extra part: $1, which is the interest you earn in the second year from the interest they paid you in the first year. The last component, which comes from reinvesting for one year the $10 you earned in interest in the first year, is called interest on interest or compound interest .
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This note was uploaded on 04/02/2009 for the course BUAD 250B taught by Professor Jackson during the Spring '07 term at USC.

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FinStatementsTaxesCashFlow_Notes - Introduction to...

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