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chapter4a

# chapter4a - Chapter 4 Time value of Money Future Values...

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Chapter 4 Time value of Money

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2 Future Values Future value: the amount of money an investment will grow to over some period of time at a given interest rate Suppose you invest \$1,000 for one year at 10% per year. What is the future value in one year? o Interest = \$1,000(.10) = \$100 o Value in one year = principal + interest = \$1,000 + 100 = \$1,100 o Future Value (FV) = \$1,000(1 + .10) = \$1,100 Suppose you leave the money in for another year. How much will you have two years from now? o FV = \$1,000(1.10)(1.10) = \$1,000(1.10) 2 = \$1,210
Future Value and Compounding The general formula for the future value of an investment over many periods can be written as FV = C 0 ×(1 + r) T Where C 0 is cash flow at date 0 r is the period interest rate T is the number of periods over which the cash is invested. Simple interest vs. compound interest Simple interest: interest is earned only on the original principal Compound interest: interest is earned on principal and on interest received

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Example You invest \$100 for two years at 10% per year Future value with simple interest = \$100 + \$10 + \$10 = \$120 Future value with compound interest = \$121 The extra \$1 comes from the interest on interest (\$10 earned in the first period) Note: When cash is invested at compound interest, each interest payment is reinvested. With simple interest, the interest is not reinvested.
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chapter4a - Chapter 4 Time value of Money Future Values...

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