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Unformatted text preview: Chapter 5 Time Value of Money Learning Objectives After reading this chapter, students should be able to: Explain how the time value of money works and discuss why it is such an important concept in finance. Calculate the present value and future value of lump sums. Identify the different types of annuities and calculate the present value and future value of both an ordinary annuity and an annuity due, and be able to calculate relevant annuity payments. Calculate the present value and future value of an uneven cash flow stream, which will be used in later chapters that show how to value common stocks and corporate projects. Explain the difference between nominal, periodic, and effective interest rates. Discuss the basics of loan amortization. Chapter 5: Time Value of Money Learning Objectives 71 Lecture Suggestions We regard Chapter 5 as the most important chapter in the book, so we spend a good bit of time on it. We approach time value in three ways. First, we try to get students to understand the basic concepts by use of time lines and simple logic. Second, we explain how the basic formulas follow the logic set forth in the time lines. Third, we show how financial calculators and spreadsheets can be used to solve various time value problems in an efficient manner. Once we have been through the basics, we have students work problems and become proficient with the calculations and also get an idea about the sensitivity of output, such as present or future value, to changes in input variables, such as the interest rate or number of payments. Some instructors prefer to take a strictly analytical approach and have students focus on the formulas themselves. The argument is made that students treat their calculators as black boxes, and that they do not understand where their answers are coming from or what they mean. We disagree. We think that our approach shows students the logic behind the calculations as well as alternative approaches, and because calculators are so efficient, students can actually see the significance of what they are doing better if they use a calculator. We also think it is important to teach students how to use the type of technology (calculators and spreadsheets) they must use when they venture out into the real world....
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- Spring '09