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Chapter 5
Formulas
Formulas
Introduction to
Valuation: The Time
Value of Money
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View Full Document Key Concepts and Skills
•
Be able to compute the future value of an
investment made today
•
Be able to compute the present value of cash
to be received at some future date
•
Be able to compute the return on an
investment
•
Be able to compute the number of periods
that equates a present value and a future
value given an interest rate
•
Be able to use a financial calculator and/or a
spreadsheet to solve time value of money
problems
5F2
Chapter Outline
•
Future Value and Compounding
•
Present Value and Discounting
•
More about Present and Future
Values
5F3
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View Full Document 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
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Opportunity cost of capital
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Required return
5F4
Future Values
•
Suppose you invest $1,000 for one year at 5%
per year.
What is the future value in one year?
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Interest = 1,000(.05) = 50
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Value in one year = principal + interest =
1,000 + 50 = 1,050
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Future Value (FV) = 1,000(1 + .05) = 1,050
•
Suppose you leave the money in 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
5F5
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View Full Document 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
5F6
Effects of Compounding
•
Simple interest
•
Compound interest
•
Consider the previous example
–
FV with simple interest = 1,000 + 50 +
50 = 1,100
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FV with compound interest = 1,102.50
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The extra 2.50 comes from the interest
of .05(50) = 2.50 earned on the first
interest payment
5F7
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View Full Document Calculator Keys
•
Texas Instruments BAII Plus
–
FV = future value
–
PV = present value
–
I/Y = period interest rate
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P/Y must equal 1 for the I/Y to be the period rate
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Interest is entered as a percent, not a decimal
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N = number of periods
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Remember to clear the registers (CLR TVM) after
each problem
–
Other calculators are similar in format
5F8
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This note was uploaded on 06/06/2011 for the course FSMA 315 taught by Professor Chengruhu during the Spring '11 term at SUNY Canton.
 Spring '11
 CHENGRUHU

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