Chapter 5 Notes

Chapter 5 Notes - Chapter 5 Introduction to Valuation The...

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Chapter 5: Introduction to Valuation: The Time Value of Money Future Value and Compounding - Future Value (FV) - amount an investment is worth after one or more periods Investing for a Single Period - If you invest for one period at an interest rate of r , your investment will grow to ( 1 + r ) per dollar invested Investing for More Than One Period - Have 4 parts: o Original Principal o Interest in 1 st year o Interest in 2 nd year o Interest earned in 2 nd year on interest paid in first year - Compounding - process of accumulating interest on an investment over time to earn more interest o Interest on Interest - interest earned on the reinvestment of previous interest payments o Called compound interest - Simple Interest - interest is not reinvested, so interest is earned each period only on the original principle - Example 5.1 - Future value of $1 invested for t periods at a rate of r per period is: o FV = $1 x ( 1 + r ) t o Future Value Interest Factor = ( 1 + r ) t o Table 5.1
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o Figure 5.1 - Future values depend critically on the assumed interest rate, particularly for long-lived
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Chapter 5 Notes - Chapter 5 Introduction to Valuation The...

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