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Classnotes_-_Chapter_5_-08

Classnotes_-_Chapter_5_-08 - Chapter 5 Classnotes Chapter...

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Chapter 5 Classnotes Chapter Five Introduction to Valuation: The Time Value of Money Chapter Outline 0. Future Value and Compounding 1. Present Value and Discounting 2. More on Present and Future Values Basic Definitions 3. Present Value – earlier money on a time line 4. Future Value – later money on a time line 5. Interest rate – “exchange rate” between earlier money and later money 0. Discount rate 1. Cost of capital 2. Opportunity cost of capital 3. Required return 1
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Chapter 5 Classnotes Future Values Suppose you invest $1000 for one year at 5% per year. What is the future value in one year? Interest = $1000 x .05 = $50 Value in one year = principal + interest = $1,050 + $1,000(1+.05) Suppose you leave the money in for another year. How much will you have two years from now? =1,050 +1,050x.05 =1,050 (1+.05) =1,000 (1+,05)^2 = $1,102.5 FV = Future Values: General Formula FV = PV(1 + r) t Where: 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 If you put $2,000 in money market account. If you earn 4% per year for 15 years, how much money will you have at the end of 15 years? FV = PV(1 + r) t FV = $2,000 (1+.04) 15 = 3,601.88 2
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Chapter 5 Classnotes Effects of Compounding 6. Simple interest 7. Compound interest 8. Consider the previous example 4. FV with simple interest = 1000 + 50 + 50 = 1100 5. FV with compound interest = 1102.50 6. The extra 2.50 comes from the interest earned on the first interest payment of . 05(50) = 2.50 Calculator Keys Texas Instruments BA-II Plus 7. N = number of periods 8. I/Y = period interest rate 0. P/Y must equal 1 for the I/Y to be the period rate 1. Interest is entered as a percent, not a decimal 9. PV = present value
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