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Chap005

# Chap005 - Chapter 5 I ntroduction to V aluation The Time V...

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Chapter 5 Introduction to Valuation: The Time Value of Money

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Basic Definitions Present Value – earlier money on a time line Future Value – later money on a time line Interest rate – “exchange rate” between earlier money and later money Discount rate Cost of capital (projects) Opportunity cost of capital Required return (stocks)
Future Values Suppose you invest \$1000 for one year at 5% per year. What is the future value in one year? Interest = 1000(.05) = 50 Value in one year = principal + interest = 1000 + 50 = 1050 Future Value (FV) = 1000(1 + .05) = 1050 Suppose you leave the money in for another year. How much will you have two years from now? FV = 1000(1.05)(1.05) = 1000(1.05) 2 = \$1102.50 The extra \$2.50 is due to compounding, or “interest-on-interest” \$50*5%=\$2.50 If we were using simple interest, the total would be \$1100.

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Future Values: General Formula FV = PV(1 + r) t FV = future value PV = present value r = period interest rate, expressed as a decimal T = number of periods Future value interest factor = (1 + r) t Abbreviated as FVIF(r,t)
Calculator Keys Texas Instruments BA-II Plus FV = future value PV = present value I/Y = period interest rate (a.k.a. r) P/Y must equal 1 for the I/Y to be the period rate Interest is entered as a percent, not a decimal N = number of periods Remember to clear the registers (CLR TVM) after each problem Set your calculator to six decimal places. Hit <2 nd > <.> and you will see “DEC=2.00”. Hit <6><ENTER> and it will change to six decimal places.

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