Ch 6 Handout - CHAPTER 6: Accounting and the Time Value of...

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CHAPTER 6: Accounting and the Time Value of Money What is interest? Interest is the excess cash received or repaid over and above the principal Interest rates are generally stated on an Two types of interest : Simple Interest Interest is computed only on the Simple interest = where: p = principal i = rate of interest for a single period n = number of periods Example: Suppose a company borrowed $1,000 for 2 years at a simple interest rate of 9%. Compound Interest Interest is computed on both: o o that has not been paid or withdrawn Interest may be compounded on an annual, semiannual, quarterly, weekly or daily basis. Terminology Used in Compound Interest Problems The value at the beginning of any time span of concern. The value at the end of any time span of concern. The rate that corresponds to the compounding period. The number of compounding periods. Compounding Period- The frequency that interest is computed. Single Sum Problems: involve a single amount of money that either exists now or will in the future Annuity Problems: involve a series of equal periodic payments (spaced equally in time) o Ordinary Annuity (OA): payments occur at the o Annuity Due (AD): payments occur at the o Deferred Annuity: payments occur 6-
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The Power of Compound Interest Example: If $1,000 is deposited today at 8% compound interest, the balance in 3 years can be determined: Using Repetitive Calculations: Using Exponential Formulas Use of Compound Interest Tables o the tables contain interest factors that simplify the computation of compound interest o the text contains: Table 6-1: Future Amount of 1 Table 6-2: Present Value of 1 Table 6-3: Future Amount of an Ordinary Annuity of 1 Table 6-4: Present Value of an Ordinary Annuity of 1 Table 6-5: Present Value of an Annuity Due of 1 1. Present Value of a Lump Sum: The amount of money that must be deposited now (today) at a specified rate of interest to amount to the lump sum at the end (future value) of a specified number of periods. 6-
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compounded semi-annually? 2. Present Value of an Ordinary Annuity 3. Annuity problems involve a series of equal periodic payments or receipts called rents. In an ordinary annuity the rents occur at the end of each period. Example: Today l 2 3 6% interest 0 $1,000 $1,000 $1,000 You could do this problem as the sum of the present values of three lump-sums. But we would not want to do the calculation this way if there were many periods.
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This note was uploaded on 01/18/2011 for the course FIN 3604 taught by Professor Patterson during the Spring '10 term at University of South Florida - Tampa.

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Ch 6 Handout - CHAPTER 6: Accounting and the Time Value of...

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