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Unformatted text preview: 1 M Pore  7.01  econ 0+A.ppt Time Value of Money 2 M Pore  7.01  econ 0+A.ppt Time Value of Money Money has a time value because it can earn more money over time ( earning power ). Money has a time value because its purchasing power changes over time ( inflation ). Time value of money is measured in terms of interest rate . Interest is the cost of money a cost to the borrower and an earning to the lender This a twoedged sword whereby earning grows, but purchasing power decreases (due to inflation), as time goes by. 3 M Pore  7.01  econ 0+A.ppt The Interest Rate 4 M Pore  7.01  econ 0+A.ppt Cash Flow Transactions for Two Types of Loan Repayment End of Year Receipts Payments Plan 1 Plan 2 Year 0 $20,000.00 $200.00 $200.00 Year 1 5,141.85 Year 2 5,141.85 Year 3 5,141.85 Year 4 5,141.85 Year 5 5,141.85 30,772.48 The amount of loan = $20,000, origination fee = $200, interest rate = 9% APR (annual percentage rate) 5 M Pore  7.01  econ 0+A.ppt Cash Flow Diagram for Plan 2 6 M Pore  7.01  econ 0+A.ppt EndofPeriod Convention 7 M Pore  7.01  econ 0+A.ppt Methods of Calculating Interest Simple interest : the practice of charging an interest rate only to an initial sum (principal amount). Compound interest : the practice of charging an interest rate to an initial sum and to any previously accumulated interest that has not been withdrawn. 8 M Pore  7.01  econ 0+A.ppt Simple Interest P = Principal amount i = Interest rate N = Number of interest periods Example: P = $1,000 i = 10% N = 3 years End of Year Beginning Balance Interest earned Ending Balance $1,000 1 $1,000 $100 $1,100 2 $1,100 $100 $1,200 3 $1,200 $100 $1,300 9 M Pore  7.01  econ 0+A.ppt Simple Interest Formula ( ) where = Principal amount = simple interest rate = number of interest periods = total amount accumulated at the end of period F P iP N P i N F N = + $1,000 (0.10)($1,000)(3) $1,300 F = + = 10 M Pore  7.01  econ 0+A.ppt Compound Interest P = Principal amount i = Interest rate N = Number of interest periods Example: P = $1,000 i = 10% N = 3 years End of Year Beginning Balance Interest earned Ending Balance $1,000 1 $1,000 $100 $1,100 2 $1,100 $110 $1,210 3 $1,210 $121 $1,331 11 M Pore  7.01  econ 0+A.ppt Compounding Process $1,000 $1,100 $1,100 $1,210 $1,210 $1,331 1 2 3 12 M Pore  7.01  econ 0+A.ppt $1,000 $1,331 1 2 3 3 $1,000(1 0.10) $1,331 F = + = Cash Flow Diagram 13 M Pore  7.01  econ 0+A.ppt Relationship Between Simple Interest and Compound Interest 14 M Pore  7.01  econ 0+A.ppt14 M Pore  7....
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This note was uploaded on 03/19/2008 for the course EE 366 taught by Professor Pore during the Spring '08 term at University of Texas at Austin.
 Spring '08
 Pore

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