Chap005

# Chap005 - Chapter 5 I ntroduction to V aluation The Time V...

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Chapter 5 Introduction to Valuation: The Time Value of Money

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Basic Definitions Present Value – today’s value of money you expect to receive in the future. (Would you rather have \$80 right now instead of \$100 a year from now?) E.g. signing bonuses Future Value – For example, if you put \$100 in the bank today at 2% interest, how much will you have in two years? Interest rate – “exchange rate” between present and future value Discount rate Cost of capital (projects) Required return (stocks)
Future Values Suppose you invest \$1000 for one year at 5% per year. What is the future value in one year? Interest = 1000(.05) = 50 Value in one year = principal + interest = 1000 + 50 = 1050 Future Value (FV) = 1000(1 + .05) = 1050 Suppose you leave the money in for another year. How much will you have two years from now? FV = 1000(1.05)(1.05) = 1000(1.05) 2 = \$1102.50 The extra \$2.50 is due to compounding, or “interest-on-interest” \$50*5%=\$2.50 If we were using “simple” interest, the total would be \$1100. (We almost never do this.)

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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 In the solutions manual, this is sometimes abbreviated as FVIF(r,t)
Time Value of Money keys Texas Instruments BA-II Plus FV = future value PV = present value I/Y = period interest rate (a.k.a. r) P/Y must equal 1 for the I/Y to be the period rate. Hit <2 nd > <I/Y> to check. Interest is entered as a percent, not a

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## This note was uploaded on 09/24/2011 for the course HADM 2225 taught by Professor Wellman, j during the Spring '08 term at Cornell.

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Chap005 - Chapter 5 I ntroduction to V aluation The Time V...

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