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Lecture6

# Lecture6 - Eco 635.02 Quick Quiz Define present value...

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Define present value, future value, and interest rate. You know the payment amount for a loan, and you want to know how much was borrowed. Do you compute a PV or a FV? What is the difference between simple interest and compound interest? What is the relationship between: PV & FV, FV (PV) & interest rate, FV(PV) & number of periods? Quick Quiz Eco 635.02 Prof. Zhylenko 1

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Lecture 6 Discounted Cash Flow Valuation Eco 635.02 Prof. Zhylenko 2
Multiple Cash Flows - FV Ways to calculate future values for multiple cash flows: 1.Compound the accumulated balance forward one year at a time 2.Calculate the future value of each cash flow first and then add them up Eco 635.02 Prof. Zhylenko 3

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Multiple Cash Flows – FV Example 1 Find the future value of \$5000 invested at the end of each of the next 5 years. The current balance is zero, and the rate is 10%. 1. Compounding forward one period at a time Today (year 0): FV = 0(1.1) = 0 Year 1: FV = 5000(1.1) = 5500 Year 2: FV = (5500 + 5000)(1.1) = 11550 Year 3: FV = (11550 + 5000)(1.1) = 18205 Year 4: FV = (18205 + 5000)(1.1) = 25525.5 Year 5: value = 25525.5 + 5000 = 30525.5 Eco 635.02 Prof. Zhylenko 4
Multiple Cash Flows – FV Example 1 Continued 2. Calculating the future value of each cash flow and adding them up Today (year 0): FV = 0(1.1) 5 = 0 Year 1: FV = 5,000(1.1) 4 = 7320.5 Year 2: FV = 5,000(1.1) 3 = 6655 Year 3: FV = 5,000(1.1) 2 = 6050 Year 4: FV = 5,000(1.1) 1 = 5500 Year 5: Value = 7320.5 + 6655 +6050 + 5500 + 5000 = = 30525.5 Eco 635.02 Prof. Zhylenko 5

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Suppose you invest \$400 in a mutual fund today, \$500 in one year, and \$600 in two years.
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Lecture6 - Eco 635.02 Quick Quiz Define present value...

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