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chp 5 - Introduction to Valuation The Time Value of Money...

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Introduction to Valuation: The Time Value of Money Chapter Five
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Chapter Outline Future Value and Compounding Present Value and Discounting More on Present and Future Values
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Basic Definitions Present Value – earlier money on a time line Future Value – later money on a time line Interest rate – “exchange rate” between earlier money and later money -Discount rate Cost of capital Opportunity cost of capital ( most explicit) Required return
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Future Values Suppose you invest $1000 for one year at 5% per year. What is the future value in one year? Interest = 50 Value in one year = principal + interest Value in one year = 1050 Future Value (FV) =1000(1+.05)=1050
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Future Values Suppose you leave the money in for another year. How much will you have two years from now? COMPOUNDING FV = 1102.5 FV = 1000(1.05)^3=1102.50
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Future Values: General Formula FV = PV(1 + r) t FV = future value PV = present value r = period interest rate, expressed as a decimal t = number of periods Future value interest factor = (1 + r) t FVIF(r,t) = (1 + r) t FVIF ( 5%,2)= (1.05)^2
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Effects of Compounding Simple interest Compound interest Consider the previous example FV with simple interest = 1050+ another 50=1100 FV with compound interest = 1102.50 The extra 2.50 comes from the interest of .05(50) = 2.50 earned on the first interest payment
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Calculator Keys Texas Instruments BA-II Plus FV = future value PV = present value I/Y = period interest rate P/Y must equal 1 for the I/Y to be the period rate Interest is entered as a percent , not a decimal N = number of periods !!Remember to clear the registers ( 2 nd [ CLR TVM ]) before each problem!!
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Calculator Keys Set interest rate I/YR to periodic rate: 2 nd [ P/Y ], 1, ENTER 2 nd [ QUIT ] Set significant digits: 2 nd [ FORMAT ] , 8, ENTER 2 nd [ QUIT ] If LCD has “BGN”: 2 nd [ BGN ] 2 nd [ SET ] 2 nd [ QUIT ]
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Future Values – Example 2 Suppose you invest the $1000 from the previous example for 5 years. How much would you have?
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