ch 5 (Time Value of Money)

ch 5 (Time Value of Money) - Question to be Asked Chapter 5...

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Chapter 5 The Time Value of Money Slide 5 - 1 Question to be Asked Suppose you are promised to be given $100 in year 0, $200 in year 1, $300 in year 2, and $400 in year 3. How about you receive $1,000 right now? Are you better off from receiving $1,000 right now? Why? This chapter discusses the time value of money, from which we determine the equivalent payment right now to receiving the money in three years. Slide 5 - 2 The Time Value of Money ± Time value of money A dollar today is better than a dollar in the future. Then, how can we compare money flows if they are at different time points? ± Two approaches Compounding: convert money flows to their future value Discounting: convert money flows to their present value Slide 5 - 3 ± Concept Present value (PV): Earlier money on a time line Future value (FV): Later money on a time line Interest rate: “exchange rate” between earlier money and later money ¾ Discount rate ¾ Opportunity cost of capital ¾ Required return Basic Definitions t=0 1 …… t-1 t Present Value Future Value
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Slide 5 - 4 Future Values ± Suppose you invest $1,000 for one year at 5% per year. What is the future value in one year? Interest = 1,000(.05) = 50 Value in one year = Principal + Interest = 1,000 + 50 = 1,050 Future value (FV) = 1,000(1 +.05) = 1,050 ± Suppose you leave the money for another year. How much will you have two years from now? FV = 1,000(1.05)(1.05) = 1,000(1.05) 2 = 1,102.50 Future value is the amount to which an investment will grow after earning interest. Slide 5 - 5 Future Values ± The General Formula FV = PV (1 + r) t Where, FV = Future value PV = Present value r = Period interest rate, expressed as a decimal t = Number of periods Future Value Interest Factor (FVIF): FVIF = (1+ r) t FV = PV × FVIF Slide 5 - 6 ± Simple Interest Simple interest assumes that the interest earned is withdrawn or spent eliminating compounding: No interest on interest. $100+(100x.05)=$105
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ch 5 (Time Value of Money) - Question to be Asked Chapter 5...

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