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Unformatted text preview: CHAPTER 5 INTRODUCTION TO VALUATION: THE TIME VALUE OF MONEY Answers to Concepts Review and Critical Thinking Questions 1. The four parts are the present value (PV), the future value (FV), the discount rate ( r ), and the life of the investment ( t ). 2. Compounding refers to the growth of a dollar amount through time via reinvestment of interest earned. It is also the process of determining the future value of an investment. Discounting is the process of determining the value today of an amount to be received in the future. 3. Future values grow (assuming a positive rate of return); present values shrink. 4. The future value rises (assuming it’s positive); the present value falls. Solutions to Questions and Problems 1. The simple interest per year is: $5,000 × .08 = $400 So after 10 years you will have: $400 × 10 = $4,000 in interest. The total balance will be $5,000 + 4,000 = $9,000 With compound interest we use the future value formula: FV = PV(1 + r ) t FV = $5,000(1.08) 10 = $10,794.62 The difference is: $10,794.62 – 9,000 = $1,794.62 2. To find the FV of a lump sum, we use: FV = PV(1 + r ) t FV = $2,250(1.10) 11 = $ 6,419.51 FV = $8,752(1.08) 7 = $ 14,999.39 FV = $76,355(1.17) 14 = $687,764.17 FV = $183,796(1.07) 8 = $315,795.75 3. To find the PV of a lump sum, we use: PV = FV / (1 + r) t PV = $15,451 / (1.07) 6 = $ 10,295.65 PV = $51,557 / (1.13) 7 = $ 21,914.85 PV = $886,073 / (1.14) 23 = $...
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This note was uploaded on 07/01/2010 for the course ECON 393 taught by Professor D during the Summer '10 term at Rutgers.
 Summer '10
 D
 Economics

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