FIN Notes 5-8.docx - FIN Notes Chapter 5 6 7 8 Chapter 5...

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FIN NotesChapter 5, 6, 7, 8Chapter 5What is the time value of money?TVM- difference between a dollar in hand today and a dollar promised in the future-dollar today is worth more than a dollar in the future because of interestFuture Value- measures the value of an investment after it earns interest for one or more periodsPresent Value- measures the current value of future cash flows discounted at the appropriate interest rateCompounding- the process of increasing cash flows to a future valueDiscounting- the process of reducing future cash flows to a present valueTimelines- effective way to visualize cash flows-outflows are negative values and inflows are positive valuesSingle-Period Investment- can determine the balance in an account at the end of a period if we know the interest rate earned on the principalTwo-Period Investment- two consecutive single-period loans-interest earned is added to the account at the end of the first period and the new account balance is the amount that earns the interest rate I during the second periodFuture Value and Compounding-to find future valuePower of Compounding-more than once a year-the more frequently interest is compounded, the larger the future value of $1 at the end of a given time period
Compounding Semi-AnnuallyContinuous Compounding-when compounding occurs on a continuous basis, the future value equation becomesFinancial Calculators-future value calculations can be done easily on a financial calculator-N is number of periods, I is the interest rate per period, PV is the present value, PMT is the amount of any recurring payments and FV is the future valuePresent Value and Discounting-a present value calculation takes end of period cash flows and reverses the effect of compounding to determine the equivalent beginning of period cash flows-this is the discounting and the interest rate I is called the discount rate-present value (PV) is often referred to as the discounted value of future cash flows-the greater the amount of time before a cash flow is to occur, the smaller the present value of the cash flow-higher the discount rate the smaller the present value of future cash flowComparing PV and FV-future value and present value formulas are one and the samePV 1 / (1+i) ^nFV (1+i) ^nFinding Interest RateMany situations require using a time value of money calculation to determine a rate of change or growth rate
-growth rate in sales-rate of return on an investment-effective interest rate on a loanThe Rule of 72-shortcut to estimate the number of periods it takes for an amount to doubleChapter 6Discounted Cash Flows and ValuationLevel Cash FlowsAnnuity- series of equally-spaced and level cash flows extending over a finite number of periodsPerpetuity- a series of equally-spaced and level cash flows that continue foreverOrdinary Annuity- cash flows occur at the end of a period (mortgage/interest payments)Annuity Due- cash flows occur at the beginning of a period (leases/car insurance)Present Value of an Annuity

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