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FMCHP4SOLUTIONS - PART 2 Important Financial Concepts...

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PART 2 Important Financial Concepts CHAPTERS IN THIS PART 4 Time Value of Money 5 Risk and Return 6 Interest Rates and Bond Valuation 7 Stock Valuation INTEGRATIVE CASE 2: ENCORE INTERNATIONAL
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Chapter 4 Time Value of Money CHAPTER 4 Time Value of Money INSTRUCTOR’S RESOURCES Overview This chapter introduces an important financial concept: the time value of money. The present value and future value of a sum, as well as the present and future values of an annuity, are explained. Special applications of the concepts include intra-year compounding, mixed cash flow streams, mixed cash flows with an embedded annuity, perpetuities, deposits to accumulate a future sum, and loan amortization. Numerous business and personal financial applications are used as examples. PMF DISK PMF Tutor : Time Value of Money Time value of money problems included in the PMF Tutor are future value (single amount), present value (single amount and mixed stream), present and future value annuities, loan amortization, and deposits to accumulate a sum. PMF Problem-Solver : Time Value of Money This module will allow the student to compute the worth of money under three scenarios: 1) single payment, 2) annuities, 3) mixed stream. These routines may also be used to amortize a loan or estimate growth rates. PMF Templates Spreadsheet templates are provided for the following problems: Problem Topic Self-Test 1 Future values for various compounding frequencies Self-Test 2 Future value of annuities Self-Test 3 Present value of lump sums and streams Self-Test 4 Deposits needed to accumulate a future sum 77
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Part 2 Important Financial Concepts Study Guide The following Study Guide examples are suggested for classroom presentation: Example Topic 5 More on annuities 6 Loan amortization 10 Effective rate 78
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Chapter 4 Time Value of Money ANSWERS TO REVIEW QUESTIONS 4-1 Future value (FV) , the value of a present amount at a future date, is calculated by applying compound interest over a specific time period. Present value (PV) , represents the dollar value today of a future amount, or the amount you would invest today at a given interest rate for a specified time period to equal the future amount. Financial managers prefer present value to future value because they typically make decisions at time zero, before the start of a project. 4-2 A single amount cash flow refers to an individual, stand alone, value occurring at one point in time. An annuity consists of an unbroken series of cash flows of equal dollar amount occurring over more than one period. A mixed stream is a pattern of cash flows over more than one time period and the amount of cash associated with each period will vary. 4-3 Compounding of interest occurs when an amount is deposited into a savings account and the interest paid after the specified time period remains in the account, thereby becoming part of the principal for the following period. The general equation for future value in year n (FV n ) can be expressed using the specified notation as follows: FV n = PV x (1+i) n 4-4
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