Lecture 5_Discounted CF II

# Lecture 5_Discounted CF II - Session 5 Discounted Cash Flow...

This preview shows pages 1–4. Sign up to view the full content.

1 Session 5: Discounted Cash Flow II Financial Management 3320 Fall 2010 Indraneel Chakraborty SMU Cox School of Business Financial Management SMU Cox School of Business © 2010 Indraneel Chakraborty 2 A review of last class Annuities Ordinary annuity : a series of identical cash flows occurring at the end of each period for some fixed number of periods Examples: consumer loans (e.g. car loans), home mortgages, etc. Annuity due : an annuity for which the cash flows occur at the beginning of each period Perpetuities Important special case of annuities: a series of identical cash flows which continues forever

This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document
2 3 Annuity and perpetuity These formulas are very important ! Ordinary annuity: Perpetuity: r r C FV r r C PV t t 1 ) 1 ( ) 1 ( 1 1 r C PV Financial Management SMU Cox School of Business © 2010 Indraneel Chakraborty 4 A review of last class: one more example You want to have \$1 million to use for retirement in 35 years. If you can earn 1% per month, how much do you need to deposit on a monthly basis if the first payment is made in one month? Formula for FV of ordinary annuity : Calculator: N = FV = I/YR = Then click PMT = 50 . 155 \$ 1 ) 01 . 1 ( 01 . 0 000 , 000 , 1 that so 01 . 0 1 ) 01 . 1 ( 000 , 000 , 1 420 12 * 35 C C Financial Management SMU Cox School of Business © 2010 Indraneel Chakraborty
5 A review of last class: one more example (continued) What if the first payment is made today? Formula for FV of annuity due : Calculator: Set Begin (you should see it on your display) N = 420 FV = 1,000,000 I/YR = 1 Then click PMT = -\$153.96 Remove Begin from your display 96 . 153 \$ 01 . 1 1 1 ) 01 . 1 ( 01 . 0 000 , 000 , 1 that so ) 01 . 1 ( 01 . 0 1 ) 01 . 1 ( 000 , 000 , 1 420 12 * 35 C C Financial Management SMU Cox School of Business © 2010 Indraneel Chakraborty 6 Perpetuity again … The PV of a perpetual cash flow stream has a finite value (as long as r > 0). Here’s a question for you: How can an infinite number of cash payments have a finite value? Hint : suppose you are considering the purchase of a consol, which promises to pay the holder \$100 per year forever. If your opportunity rate is 10%, what is the most you would pay for the bond today? One more question : Assume you are offered a bond identical to the one described above, but with a life of 50 years. What is the difference in value between the 50-year bond and the consol? Financial Management

This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document
This is the end of the preview. Sign up to access the rest of the document.

## This note was uploaded on 09/20/2010 for the course FINA 3320 taught by Professor Lewis,m during the Spring '08 term at Southern Methodist.

### Page1 / 14

Lecture 5_Discounted CF II - Session 5 Discounted Cash Flow...

This preview shows document pages 1 - 4. Sign up to view the full document.

View Full Document
Ask a homework question - tutors are online