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Chapter 4
Introduction to Valuation: The Time Value of Money
The market value of an asset is determined by the amount, timing, and risk of an asset’s cash flows.
In this chapter, we learn the formula for calculating the market value of a set of cash flows and how
it relates to the amount, timing, and risk of cash flows.
Before we discuss the calculation of market value, we start with a more intuitive problem: What is
the future value of a set of cash flows?
What is the future value of a time 0 cash flow (equal to PV) t periods in the future?
Formula
: FV
t
= PV (1+r)
t
Example
: You put $100 in the bank. The bank pays 5% interest per year. What is your bank
balance in 3 years?
Formula
:
Calculator
:
N
I/Y
PV
PMT
FV
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View Full Document A Closer Look at the Future Value Formula
You put $100 in the bank.
The bank pays 5% interest a year.
What is your bank balance in 1 year?
Formula:
How much do you have in the bank after 2 years?
Formula:
How much do you have in the bank after 3 years?
Formula:
Combine the formulas:
Formula:
General formula:
Formula:
2
Compound Interest vs. Simple Interest
The previous example assumed that we were compounding interest once every year. Most
transactions assume that interest is compounded. Simple interest would only calculate interest on the
amount deposited in the bank.
Example
: You put $100 in the bank. The bank pays 5% interest a year. Compute the amount of
money at the bank after 1 year, 2 years, and 3 years using simple interest and compound interest
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This note was uploaded on 04/29/2008 for the course FINANCE 3320 taught by Professor Wigmans,f during the Spring '08 term at Texas Tech.
 Spring '08
 Wigmans,F
 Time Value Of Money, Valuation

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