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5&amp;6-TVM

# 5&amp;6-TVM - CorporateFinance USC Dr.Bemis...

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Corporate Finance USC Dr. Bemis

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Key Concepts and Skills Be able to compute the future value of an  investment made today Be able to compute the present value of cash  to be received at some future date Be able to compute the return on an  investment
Basic Definitions Present Value – earlier money on a time line Future Value – later money on a time line Interest rate – “exchange rate” between earlier  money and later money Discount rate Cost of capital Opportunity cost of capital Required return

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Future Values Suppose you invest \$1,000 for one year at 5% per  year.  What is the future value in one year? Interest = 1,000(.05) = 50 Value in one year = principal + interest = 1,000 +  50 = 1,050 Future Value (FV) = 1,000(1 + .05) = 1,050 Suppose you leave the money in for another year.   How much will you have two years from now? FV = 1,000(1.05)(1.05) = 1,000(1.05) 2  = 1,102.50
Future Values: General Formula FV = PV(1 + r) t FV = future value PV = present value r = period interest rate, expressed as a  decimal T = number of periods Future value interest factor = (1 + r) t

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Effects of Compounding Simple interest (interest is earned only  on the original principal) Compound interest (interest is earned  on principal and on interest received)
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Future Values – Example Suppose you invest the \$1,000 from the  previous example for 5 years. How much  would you have? FV = 1,000(1.05) 5  = 1,276.28 The effect of compounding is small for a small  number of periods, but increases as the  number of periods increases.

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Future Value as a General Growth Formula Suppose your company expects to
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