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Chapter 04 Financial Management

Chapter 04 Financial Management - Financial Management ADM...

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© 2007 Dr. William F. Rentz & Associates, All Rights Reserved 1 Financial Management ADM 2350 Professor: Dr. William F. Rentz
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© 2007 Dr. William F. Rentz & Associates, All Rights Reserved 2 ADM 2350 Chapter 4 Discounted Cash Flow Analysis This session introduces the concepts and skills necessary to understand the time value of money and its applications 2
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© 2007 Dr. William F. Rentz & Associates, All Rights Reserved 3 Simple and Compound Interest Simple Interest Interest paid on the principal sum only Compound Interest Interest paid on the principal and on prior interest that has not been paid or withdrawn
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© 2007 Dr. William F. Rentz & Associates, All Rights Reserved 4 PMT to denote cash payment PV to denote the present value dollar amount T to denote the tax rate I to denote simple interest i to denote the interest rate per period n to denote the number of periods Notation 4
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© 2007 Dr. William F. Rentz & Associates, All Rights Reserved 5 t to denote time PV 0 = principal amount at time 0 FV n = future value n time periods from time 0 Notation 5
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© 2007 Dr. William F. Rentz & Associates, All Rights Reserved 6 Future Value of a Cash Flow At the end of year n for a sum compounded at interest rate i is FV n = PV 0 (1 + i ) n Formula
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© 2007 Dr. William F. Rentz & Associates, All Rights Reserved 7 Simple vs. Compound Interest Suppose you wish to invest $100 for 3 years at 10% interest. If interest is calculated on a simple interest basis, then interest is paid only on the original principal amount. I = PV 0 x i x n = $100 x 10% x 3 = $30
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© 2007 Dr. William F. Rentz & Associates, All Rights Reserved 8 Simple vs. Compound Interest Thus, after 3 years, the total funds that you would accumulate are PV 0 + I = $100 + $30 = $130
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© 2007 Dr. William F. Rentz & Associates, All Rights Reserved 9 Simple vs. Compound Interest In modern economies, interest is compounded.
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