Business Finance EXAM 2 NOTES.docx - Business Finance(Start...

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Business Finance (Start of Exam 2) Lecture notes/Book Notes Chapter 5: The Time Value of Money Lecture 2/1/16: THE TIME VALUE OF MONEY Time is your best friend, the sooner you start saving for long-term future the easier it will be. What is Time Value of money about? "Time affects the value of money" Opportunity Cost associated with waiting on money Example: receiving 100$ now at the beginning of the semester or waiting until the end of semester to get 110$ (extra ten) = 10% return COMPOUNDING AND DISCOUNTING SINGLE SUMS When we say "compounding" think of "future" When we say "discounting" think "present" Single sum=one time cash flow Interest (rate) captures/measures opportunity cost If we measure this opportunity cost we can: Translate $1 into it's equivalent in the future ( compounding ) OR translate 1$ in the future into it's equivalent today ( discounting ) Synonyms : interest rates/opportunity cost/discount rate/required return FUTURE VALUE- How to find a future value of a single sum (one time cash flow): EXAMPLE: If we deposit $100 into an account earning 6% how much would you have in this account after one year? Multiply (100)×(.06)=6$ then add this to 100=$ 106 How to find this on a calculator: P/Y (PAYMENT PER YEAR)=1 I (INTEREST)=6 N (LENGTH OF TIME FOR WHICH DEPOSITING MONEY)=1 PV (AMOUNT OF DEPOSIT)=−100 1. Type "1" 2nd orange key 2. Type "6" I/YR (top row 2nd button) 3. Type "1" and then N (top row 1st button) 4. Type "100" then ± key to make negative 5. Last type FV (top row last button) to get our future value General Rule: whenever entering a present value number into calculator enter it with a negative sign and vise versa for future value EXAMPLE: If we deposit $100 into an account earning 6% how much would you have in this account after 5 years? P/Y (PAYMENT PER YEAR)=1 I (INTEREST)=6 N (LENGTH OF TIME FOR WHICH DEPOSITING MONEY)=5 PV (AMOUNT OF DEPOSIT)=−100 1. Type "1" 2nd orange key 2. Type "6" I/YR (top row 2nd button) 3. Type "5" and then N (top row 1st button) 4. Type "100" then ± key to make negative 5. Last type FV (top row last button) to get our future value 133.82 EXAMPLE: If we deposit $100 into an account earning 6% with quarterly compounding how much would you have in this account after 5 years? P/Y (PAYMENT PER YEAR)=4 I (INTEREST)=6 N (LENGTH OF TIME FOR WHICH DEPOSITING MONEY)= 20 Quarters (4)×(5)=20
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PV (AMOUNT OF DEPOSIT)=−100 134.69$ EXAMPLE: If we deposit $100 into an account earning 6% with monthly compounding how much would you have in this account after 5 years? P/Y (PAYMENT PER YEAR)=12 I (INTEREST)=6 N (LENGTH OF TIME FOR WHICH DEPOSITING MONEY)= 60 Quarters (12)×(5)=60 PV (AMOUNT OF DEPOSIT)=−100 134.89 Two Important things when testing: If we say two things have a positive or a direct relationship , what we mean is if "one goes up, the other one goes up" if we say two thing have a negative or inverse relationship , what we mean is if "one goes up, the other goes down" What is the relationship: (positive) o The higher the interest rate (I) the higher the future value (FV) will be o
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