{[ promptMessage ]}

Bookmark it

{[ promptMessage ]}

393_lecture6

# 393_lecture6 - Time Value of Money Lecture 6 Myung Joo Song...

This preview shows pages 1–9. Sign up to view the full content.

Time Value of Money Lecture 6 Myung Joo Song ECON 393 Fall 2011 Myung Joo Song (ECON 393) Time Value of Money Fall 2011 1 / 31

This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document
Chapter Outline Future Value and Compounding Present Value and Discounting More about Present and Future Values (Examples) Myung Joo Song (ECON 393) Time Value of Money Fall 2011 2 / 31
Present and Future Value Present Value: earlier money on a time line. Future Value: later money on a time line Single Future Cash Flow in this lecture. (Next lecture, multiple Future Cash Flows) Interest and Interest Rate: ”Exchange rate” between earlier money and later money. Discount rate Cost of capital Opportunity cost of capital Required return Myung Joo Song (ECON 393) Time Value of Money Fall 2011 3 / 31

This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document
Future Value: One period Suppose you deposit present value of \$1,000 in your saving account for one year at 5% interest rate per year. What is the future value in one year? You collect after 1 year: Interest = 1,000(.05) = \$50 Principal or Present Value = \$1000 Future Value (FV) = 1,000 +1000 (.05) = \$1,050 Note that: Future Value = Principal + Interest Payments Myung Joo Song (ECON 393) Time Value of Money Fall 2011 4 / 31
Future Value: Two and More Periods Suppose you leave the money in for another year. How much will you have two years from now? After first year you receive \$1050: Principal of \$1000 Interest of \$50 After second year you receive 1000+1050(.05): Principal of \$1000 Interest of 1050*(.05) = 1000 (.05)+50(.05) 50(.05) is interest on interest FV = 1000*(1+.05)(1+.05) = PV(1 + interest rate) 2 Myung Joo Song (ECON 393) Time Value of Money Fall 2011 5 / 31

This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document
Future Value: General Formula Single cash flow formula: FV = PV (1 + r ) T = PV (1 + r )(1 + r ) ... (1 + r ) | {z } T times where FV: Future Value or Future Cash Flow PV: Amount you invest r: Interest rate per one period - discount rate T: Number of periods Myung Joo Song (ECON 393) Time Value of Money Fall 2011 6 / 31
Effects of Compounding Simple interest: Calculated on the original principal (e.g. \$1000) only. Compound interest: Calculated on the original principal and all interest accumulated (Interest on Interest) In 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 Myung Joo Song (ECON 393) Time Value of Money Fall 2011 7 / 31

This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document
Example: Future Values Suppose you invest the \$1,000 from the previous example for 5 years. How much would you have? PV=1000; r = 5% per period, T = 5 Future Value = 1000(1 + 5%) 5 = \$1,276.28 Without compounding: FV = PV+PV x r x T = 1000 + 1000 x 5% x 5 = \$1250 The effect of compounding is small for a small number of periods, but increases as the number of periods increases. Can you show this?
This is the end of the preview. Sign up to access the rest of the document.

{[ snackBarMessage ]}

### Page1 / 33

393_lecture6 - Time Value of Money Lecture 6 Myung Joo Song...

This preview shows document pages 1 - 9. Sign up to view the full document.

View Full Document
Ask a homework question - tutors are online