Chapter4nt[1]

# Chapter4nt[1] - 1 Chapter 4 Time Value of Money 1 Analyzing...

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Unformatted text preview: 1 Chapter 4 Time Value of Money 1: Analyzing Single Cash Flows 2 Chapter 4 Learning Goals LG1: Create a cash flow time line LG2: Compute the future value of money LG3: Use the power of compounding to increase wealth LG4: Calculate the present value of a payment made in the future LG5: Move cash flows from one year to another LG6: Apply the Rule of 72 LG7: Compute the rate of return LG8: Calculate the number of years needed to grow an investment to a specific amount of money 3 Introduction • The ability to work problems using the principles of the Time Value of Money will be one of them most important skills you will learn – Financial managers – Any kind of manager in businesses of all sizes – Personal life 4 • The basic idea behind the time value of money is that \$1 today is worth more than \$1 promised next year • Factors to consider: – Size of the cash flows – Time between the cash flows – Rate of return • Opportunity cost • Interest rate • Required rate of return • Discount rate 5 Organizing Cash Flows • A helpful tool for analysis of cash flows is the time line, which shows the magnitude of cash flows at different points in time – Cash we receive is called an inflow and is represented by a positive number – Cash that leaves us is called an outflow and is represented by a negative number Cash flow- 100 105 5% Period 1 2 6 Single-period Future Value • You invest \$100 today in an account earning 5% per year. Compute the future value in one year. Value in one year = Today’s cash flow + Interest earned = \$100 + (\$100 x 0.05) = \$100 x (1 + 0.05) = \$105 In general: FV = PV x (1 + i) N 7 Compounding and Future Value • In the example above, suppose you leave the money invested for two years. What is the future value? Value in 2 years = \$100 x (1 + 0.05) 2 = \$110.25 • The total interest of \$10.25 represents \$10 earned on the original \$100 investment plus \$0.25 earned on the \$5 first year’s interest – This represents compounding, i.e. earning interest on interest Financial Calculators N I PV PMT FV Financial calculators generally have TVM keys similar to the following: N = number of interest periods N = number of interest periods I = interest per period N = number of interest periods I = interest per period PV = present value N = number of interest periods I = interest per period PV = present value PMT= payment (annuity) N = number of interest periods I = interest per period PV = present value PMT= payment (annuity) FV = future value Reset P/Yr = 1 9 Financial Calculator Solution INPUT 2 5 -100 N I/YR PV PMT FV OUTPUT 110.25 10...
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Chapter4nt[1] - 1 Chapter 4 Time Value of Money 1 Analyzing...

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