Chapter 5 &amp; 6

# Chapter 5 &amp; 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 landlord’s 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 don’t 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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## This note was uploaded on 11/24/2009 for the course BA 3341 taught by Professor Polkovnichenko during the Fall '08 term at University of Texas at Dallas, Richardson.

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

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