CashFlow&Interest

CashFlow&Interest - Cash Flows, Interest Rates and...

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Cash Flows, Interest Rates and the Time Value of Money
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Definitions Project : an investment opportunity generating cash flows over time Cash Flow : the movement of money (in or out) of a project Interest : used to move money through time for comparisons. The rent for loaned money Cash Flow Diagram : Describes type, magnitude and timing of cash flows over some horizon
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Cash Flow Diagram Describes type, magnitude and timing of cash flows over some horizon 0 1 2 3 4 5 500K 200K 50K 100K 200K 500K
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Cash Flow Diagram Used to describe any investment opportunity. Typical investment:
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Cash Flow Diagram Used to describe any investment opportunity. Typical investment: 0 P Make an initial investment (purchase) at “time 0”
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Cash Flow Diagram Used to describe any investment opportunity. Typical investment: 0 1 2 T Receive revenues and pay expenses over time. P
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Cash Flow Diagram Used to describe any investment opportunity. Typical investment: 0 1 2 T Write as a NET cash flow in each period. P
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Cash Flow Diagram Used to describe any investment opportunity. Typical investment: 0 1 2 T SV P Receive salvage value at end of life of project.
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Time Value of Money We need to compare cash flow diagrams to pick from a choice of projects To describe the same amount of money at different periods of time requires the use of interest. Generally, money grows (compounds) into larger future sums and is smaller (discounted ) in the past.
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Interest Cost of Money Rental amount charged by lender for use of money In any transaction, someone “earns” and someone pays Savings Account: bank pays you; 1.5% fee to depositor Home/Auto Loan: borrower pays bank; 7.5% fee to bank
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Interest Interest Rate comprised of many factors Example: Home Mortgage: 7.5% Prime Rate : Banks receive money at this rate => 5% Risk Factor : => 1% Administration Fees : => .5% Profit : => 1%
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Definitions Principal: P : capital Amount invested or loaned Interest Rate: i Rental charge for money defined as a percentage of principal per time period Compounding Period Defines how often interest is calculated (may not be paid, however) Length of loan/investment: n periods
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Interest Interest earned/paid is directly proportional to capital involved. I = P * i * n
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CashFlow&Interest - Cash Flows, Interest Rates and...

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