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Chap005

# Chap005 - Chapter 5 Formulas F ormulas I ntroduction to V...

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Chapter 5 Formulas Formulas Introduction to Valuation: The Time Value of Money

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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 5F-2
Chapter Outline Future Value and Compounding Present Value and Discounting More about Present and Future Values 5F-3

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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 Required return 5F-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 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 5F-5

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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 5F-6
Effects of Compounding Simple interest Compound interest Consider the previous example FV with simple interest = 1,000 + 50 + 50 = 1,100 FV with compound interest = 1,102.50 The extra 2.50 comes from the interest of .05(50) = 2.50 earned on the first interest payment 5F-7

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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
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