Chapter 4
Interest
= interest rate + initial investment
FV = P x (1+r)^t
Compound Interest
interest earned on interest
Simple Interest
interest earned only on the original investment; no interest is earned
on interest
Compound Growth
means that the value increases each period by the factor (1 +
growth rate) the value after t periods will equal the initial value times (1+growth
rate). When $ is invested at compound interest, the growth rate is the interest rate
PV = FV/(1+r)^t
Discounted Cash Flow
another term for the PV of a future cash flow
Discount Rate
irate used to compute PV’s of future cash flows
Discount Factor
PV of a $1 future payment
Finding Interest Rates
when solving for irate, move everything to other side and
multiply the exponent x to 1/x on the other side
Cash Flows
To find the value at some future date of a stream of cash flows
, calc what each cash flow
will be worth at that future date, and then add up these future values.
The PV of a stream of cash future cash flows is that u need to invest today to generate
that stream
ANNUITY
equally spaced level stream of cash flows w/a finite maturity
Value of an annuity is = to the diff btwn the value of 2 perpetuties
**annuity is equivalent to the diff btwn an immediate and a delayed
perpetuity
PV of tyr annuity = C{1/r – 1/r(1+r)^t} OR (payment x annuity factor)
Annuity factor
PV of a $1 annuity
PERPETUITY
stream of level cash payments that never ends
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View Full DocumentPV of Perpetuity = cash payment / irate
Both Perpetuity and Annuity formulas assume that the 1
st
payment happens at end of
period.
Annuities Due
Level stream of cash flows due immediately
PV of Annuity Due = (1+r) x PV of an Annuity
FV of Annuity of $1 a yr = PV of annuity of $1 a yr
X
(1+r)^t
(1+r)^t – 1 / r
FV of an Annuity due = FV of ordinary annuity x (1+r)
INFLATION
rate at which prices as a whole are increasing
CPI
how economists track the general level of prices. It measures the # of $ that it
takes to buy a specified basket of goods/services that is supposed to represent the typical
familys purchases
% inc of CPI yrtoyr measures the rate of inflation
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 Spring '08
 Genco
 Time Value Of Money, Net Present Value

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