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Lecture 3 - Lecture3 Inthischapter,. (usuallymorethan)...

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Lecture 3 In this chapter, we look at the concept of  time value of money .  Time value of money refers to the fact that a  dollar in hand today is worth no less than (usually more than) a dollar promised at some time in the future.  Hence, to determine the value current value of cash flows expected in the future is one of the most  important issues faced by a financial manager. As we saw in the earlier chapter, there exists an interest rate which was defined as the cost of money.  The  reason there is a time value of money is due to an interest rate.  From a view of borrower, it is the cost to  get the right to use the money for a given period.  From lender’s perspective, it is the value that he/she can  get by giving up the right to use the money for a given period of time.  Therefore, interest rate can be often  considered as the time value of money. Cash flow time line  – a tool used in time value of money analysis.  Although, it is very simple, this  technique will help you visualize when the cash flows associated with a particular situation occur.   It is  highly recommended to use the time line when you try to solve time value of money questions. An example of time line: Time       0   5%   1           2             3           4 |----------|----------|----------|----------|    Cash flows          0        $20       -$20           0            0 Time 0 is today, and time increases by an increment (period).  Usually, we put periodic interest rate  between periods.  As shown in the example, the periodic interest rate between time 0 and time 1 is 5%.  The bottom half of the time line represents cash flows.  For example, there is a cash  inflow , a receipt of  cash, at time 1.  We know this is cash inflow because the cash flow is positive.  On the other hand, there is  a cash  outflow , a payment of cash, at time 2.  Why is this cash outflow? Future Value Future value  – the amount an investment is worth after one or more period.  Mathematically, the future  value can be expressed as: FV n  = PV(1 + i) n Sometimes, (1 + i) n  is called  FVIF i,n , (Future Value Interest Factor for i and n).  For example, suppose you deposit $100 in a savings account that pays 5% interest rate per year.  At the end  of the first year, the investment will grow to $105.  This is a very simple one period case.  However, as the 
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