FIN301Ch5,7,9 - Finance 2/22/11 Chapter 5 Omit 5-8 Time...

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Finance 2/22/11 Chapter 5 – Omit 5-8 – Time Value of Money Time Lines – an important tool used in time value analysis; it is a graphical representation used to show the timing of cash flows. Moving sums of money though time WITHOUT changing its relative equivalency Moving Forward – COMPOUNDING – Future Value Moving backward – DISCOUNTING – Present Value Future Values (FV) – The amount to which a cash flow or series of cash flows will grow over a given period of time when compounded at a given interest rate Present Value (PV) – The value today of a future cash flow or series of cash flows. Compounding – The arithmetic process of determining the final value of a cash flow or series of cash flows when compound interest is applied…. PV and need to find FV ASSUMPTION OF COMPOUNDING – all cash flows are REINVESTED at the SAME RATE as the ORGINIAL INVESTMENT Symbolic Representations o PV = Present Value (time zero) o FV = Future Value o PMT = Annuity Payments o I = annual rate of interest (increase) o N = Number of years of compounding/discounting o i/y = Periodic interest rate o CF = Cash Flow (of Particular period) Lump Sum – How much will $100 invested today in an account that pays an annual interest rate of 10%? o Check worksheet Present Values o Opportunity Cost – The rate of return you could earn on alternative investment of similar risk o Discounting – the process of finding the present value of a cash flow or a series of cash flows; discounting is the reverse of compounding…. . FV and need to find PV o Be indifferent if T-Bond and CD are the same. o I offer you $1000, but you have to wait three years for it. The opportunity cost of waiting those three years in the FOREGOING THE INTEREST on that money for three years. o The opportunity cost, expressed as a percentage, is the Discount Rate Finding the Interest Rate, i o Check worksheet Annuities – A series of equal payments at FIXED intervals for a specified number of periods o Ordinary (or deferred) Annuity – An annuity whose payments occur at the end of each period. o Annuity Due – An annuity whose payments occur at the beginning of each period
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Future Value of an ordinary annuity o Check worksheet Perpetuities o Consol – a perpetual bond issued by the British government to consolidate past debts; in general, any perpetual bond. o Perpetuity – A stream of equal payments at fixed intervals expected to continue forever. Can’t use a step by step approach See worksheet o When interest rates change, the prices of outstanding bonds also change. Bond prices decline when rates rise and increase when rates fall. Uneven Cash Flows
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This document was uploaded on 11/02/2011 for the course FIN 301 at Miami University.

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FIN301Ch5,7,9 - Finance 2/22/11 Chapter 5 Omit 5-8 Time...

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