CHAPTER 4: TIME VALUE OF MONEY
A. OVERVIEW
Motivation
: Which one would you choose: $100 now or $100 ten years later? Why?
Definition:
Time value of money refers to the belief that a dollar now is worth more than a dollar that
will be received at a later time
Terms:
•
Present value: Bring the future dollar amount to the present by
discounting
•
Future value: Bring the present dollar amount to a reference point in the future by
compounding
B. FUTURE VALUE: ONE LUMP SUM
Definition:
Compound interests are interests earned on a principal and become part of the principal at
the end of each period
Definition:
Future value is the value of the present amount by applying and adding compound interests
over a specified period of time
I. Warmup question: Simple interest
Example 1
: Suppose Diana lends $100 to Michael. Interest is calculated as simple interest at an annual
rate of 8%. What is the future value (FV1) of $100 after 1 year?
Example 2
: Suppose Michael borrows for 2 years. Find FV2.
II. Compound interest
Example 3
: Suppose Michael borrows for 2 years, at an annual interest rate of 8%, compounded
annually. Find FV2.
Example 4
: What about n years?
General formula: Future value, one lump sum, with compound interest
Example 5:
Find the future value of $100 after 30 years, compounded at an annual rate of 8 percent.
Example 6:
What if $100 compounded semiannually at an annual interest of 8% for 2 years?
General formula: Future value, one lump sum, with compound interest compounded frequency m
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 Fall '10
 thomasrhee
 Time Value Of Money, Future Value, Nominal Interest Rate

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