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Ch4 - CHAPTER 4 TIME VALUE OF MONEY A OVERVIEW Motivation...

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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. Warm-up 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 semi-annually at an annual interest of 8% for 2 years?

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