Chapter 5 & 6

Chapter 5 & 6 - 1 BA 3341 Business Finance Nataliya...

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Unformatted text preview: 1 BA 3341 Business Finance Nataliya Polkovnichenko, Senior Lecturer 2 2 2 3 A dollar today is better than a dollar in the future. Just as rent is a landlords compensation for the use of an apartment, investors need to be compensated for the use of their money. We call the rent for the use of money interest . For now we will delay the discussion of how this rent is established, and focus on the impact of interest on financial decisions. 4 If a bank pays 6% interest on deposits, how much will a deposit of $100 earn, in interest, in one year? How much money will you have accumulated in your account after one year? How much money will you have accumulated in your account after two years? 5 The future value relationship assumes that interest is compounded. (Interest is earned on interest) Year One $100 x 1.06 = $106 Year Two $106 x 1.06 = $112.36 Year Three $112.36 x 1.06 = $119.10 Year Four $119.10 x 1.06 = $126.25 Year Five $126.25 x 1.06 = $133.82 This compounding is expressed exponentially Future Value $100 x (1.06) 5 = $133.82 6 7 Simple Interest- Interest paid only on the original investment. (No interest on interest) Using the same 6% example: Year One $100 x 1.06 = $106 Year Two $106+(100x.06)= $112 Year Three $112+(100x.06)= $118 Year Four $118+(100x.06)= $124 Year Five $124+(100x.06)= $130 The simple interest method results in ______ less in accumulated value after five years. 8 The longer the investment period the greater the impact of compound interest. $1,000 invested at 6% for 30 years annually compounded is ? Simple interest would result in ? 9 The higher the interest rate the greater the impact of compound interest. $1,000 invested at 10% for 30 years annually compounded is: Simple interest would result in ? 10 11 What is the future value of $3,000,000 invested for 5 years at 7%? What is the future value of $3,000,000 invested for 30 years at 8%? Calculate the Future Value Factors (1+rate) # of periods from above. 12 What is the future value of $3,000,000 invested for 5 years at 7%? PMT=0, PV = 3,000,000, N = 5, I/Y = 7% : FV= What is the future value of $3,000,000 invested for 30 years at 8%? PMT=0, PV = 3,000,000, N = 30, I/Y = 8% : FV = Future Value Factor is the FV of $1.00 PV = 1, N = 5, I/Y = 7% : FV Factor = PV = 1, N = 30, I/Y = 8% : FV Factor= 13 Time Value of Money (TVM) problems involve identifying the payment or receipt of cash over time. A useful tool in the analysis of these problems is the timeline illustrated below. Years or Periods Cashflows 0 1 2 3 4 CF 0 CF 1 CF 2 CF 3 CF 4 5 CF 5 14 You deposited $100 today and you will deposit $300 one year from today (you dont withdraw any money from your bank account!) Interest rate is 4% compounded yearly What is the value of your deposit four years from today? from today?...
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Chapter 5 & 6 - 1 BA 3341 Business Finance Nataliya...

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