bapp03 - Appendix C OBJECTIVES Time Value of Money STUDY...

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Time Value of Money Appendix C C1 Would you rather receive $1,000 today or a year from now? You should prefer to receive the $1,000 today because you can invest the $1,000 and earn interest on it. As a result, you will have more than $1,000 a year from now. What this example illustrates is the concept of the time value of money . Everyone prefers to receive money today rather than in the future because of the interest factor. STUDY OBJECTIVES After studying this appendix, you should be able to: 1 Distinguish between simple and compound interest. 2 Identify the variables fundamental to solving present value problems. 3 Solve for present value of a single amount. 4 Solve for present value of an annuity. 5 Compute the present value of notes and bonds. NATURE OF INTEREST Interest is payment for the use of another person’s money. It is the difference be- tween the amount borrowed or invested (called the principal ) and the amount re- paid or collected.The amount of interest to be paid or collected is usually stated as a rate over a specific period of time. The rate of interest is generally stated as an annual rate . The amount of interest involved in any financing transaction is based on three elements: 1. Principal ( p ): The original amount borrowed or invested. 2. Interest Rate ( i ): An annual percentage of the principal. 3. Time ( n ): The number of years that the principal is borrowed or invested. Simple Interest Simple interest is computed on the principal amount only. It is the return on the principal for one period. Simple interest is usually expressed as shown in Illustration C-1 on the next page. Distinguish between simple and compound interest. STUDY OBJECTIVE 1 PDF Watermark Remover DEMO : Purchase from www.PDFWatermarkRemover.com to remove the watermark
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C2 Appendix C Time Value of Money Interest Hh h For example, if you borrowed $5,000 for 2 years at a simple interest rate of 12% annually, you would pay $1,200 in total interest computed as follows: Interest H p h i h n H $5,000 h .12 h 2 H $1,200 Time n Rate i Principal p Illustration C-1 Interest computation Compound Interest Compound interest is computed on principal and on any interest earned that has not been paid or withdrawn. It is the return on the principal for two or more time periods. Compounding computes interest not only on the principal but also on the interest earned to date on that principal, assuming the interest is left on deposit. To illustrate the difference between simple and compound interest, assume that you deposit $1,000 in Bank Two, where it will earn simple interest of 9% per year, and you deposit another $1,000 in Citizens Bank, where it will earn com- pound interest of 9% per year compounded annually . Also assume that in both cases you will not withdraw any interest until three years from the date of deposit.
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bapp03 - Appendix C OBJECTIVES Time Value of Money STUDY...

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