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Unformatted text preview: 11LECTURE 3 – Semester 1, 2009CORPORATE FINANCE7211AFE12Concepts Covered Today•Understand Time Value of Money•Simple Interest and Compound Interest•Calculation of Present and Future Values•Effective Annual Rates•Calculation of PV and FV of Ordinary Annuity and Annuity due•Calculation of PV of a Perpetuity13Fundamental principles of Finance•There is a time value of money•Risk expects an appropriate returnEverything in finance builds upon these two principles14Fundamental principles of FinanceWhy is there a time value of money?15Fundamental principles of FinanceWhy is there a time value of money?•Money can earn interest (tautological)•Rather consume now than later•Inflation can erode value of money16Fundamental principles of FinanceWhy does risk expect an appropriate return?17Fundamental principles of FinanceWhy does risk expect an appropriate return?•We are risk averse•More risk, we want more return18Some warmup questionsYou deposit $100 in a savings account that pays 5%. How much will you have the end of one year?19Some warmup questionsYou deposit $100 in a savings account that pays 5%. How much will you have the end of one year?You invested $1,000 in a stock a year ago. The stock is now worth $1,200. What was your return over the past year?110Some warmup questionsYou put money in a highyield deposit that pays 10%. You now have $600. How much did you deposit a year ago?111Some warmup questionsYou put money in a highyield deposit that pays 10%. You now have $600. How much did you deposit a year ago?You deposit $200 in a savings account that pays 10%. How much will you have the end of two years?112Terminology of Financial Mathematics•Cash Flows ($ Inflows and Outflows)•Rate of Return (earned by an investor) (use symbol r ork)•Interest Rate (used when the agreement is in the form of debt) (use symbol ror i )113Simple v Compound Interest: the basics•Compounding interest is earning (or paying) interest on interest. •Simple Interest is used when there is only a single time period involved.114Simple Interest Example 1Suppose you borrow $1000 and agree to repay at 12% p.a. (per annum) interest in 1 year. Calculate the interest and principal component?Interest owed = 1000 * 0.12 = $120 = PrTotal repayment = $1000 + $120 = $1120In general: FV= P+ Pr=P(1+r)115Simple Interest Example 2Calculate the repayment of a loan of $10,000 after 6 months, interest @ 8% p.a.interest rate r= 0.08*(6/12) = 0.04FV= P(1 + r) = $10,000 x 1.04= $10,400Thus you would repay $10,400 at the end of 6 months.116Future ValueFuture Value (FV) is the value of an investment or loan at some point in the future....
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This note was uploaded on 10/10/2010 for the course ECON 7300 at University of Sydney.
 '09
 RezaMonem
 Accounting

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