Chapter_4_Fall2011_s

Chapter_4_Fall2011_s - 1 Chapter 1 Introduction to...

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Unformatted text preview: 1 Chapter 1 Introduction to Corporate Finance FI 311 Gregory Sabin Chapter 4 Intro: The Time Value of Money FI 311 Elizabeth Booth Chapter 4 Introduction to Valuation: The Time Value of Money 2 Chapter 1 Introduction to Corporate Finance FI 311 Gregory Sabin Chapter 4 Intro: The Time Value of Money FI 311 Elizabeth Booth Key Concepts and Skills • Be able to compute the future value of an investment made today • Be able to compute the present value of cash to be received at some future date • Be able to compute the return on an investment • Be able to compute the number of periods that equates a present value and a future value given an interest rate • Be able to use a financial calculator and a spreadsheet to solve time value of money problems 3 Chapter 1 Introduction to Corporate Finance FI 311 Gregory Sabin Chapter 4 Intro: The Time Value of Money FI 311 Elizabeth Booth Basic Definitions • Present Value – the economic value in “today’s” terms of some future cash flow • Future Value – the economic value in “tomorrow’s” terms of a cash flow today. The amount to which an investment will grow to after earning interest. • Interest rate – “exchange rate” between earlier money and later money – Discount rate – Cost of capital – Opportunity cost of capital – Required return 4 Chapter 1 Introduction to Corporate Finance FI 311 Gregory Sabin Chapter 4 Intro: The Time Value of Money FI 311 Elizabeth Booth Simple Interest • You deposit $100 in a bank account that generates 6% simple interest. How much will you have in your account one year from today, assuming that you don’t deposit or withdraw any amount from it? • FV = 100 +100*6% = $106 • How much will you have two years from today? • FV = 100+100*6*2 = $112 • How much n years from today? • FV = 100+100*6*n 5 Chapter 1 Introduction to Corporate Finance FI 311 Gregory Sabin Chapter 4 Intro: The Time Value of Money FI 311 Elizabeth Booth Problem 1: page 82 • See p.82 for Problem 1. • FV = PV( 1+ i) ᴺ – FV = future value – PV = present value – i = period interest rate, expressed as a decimal – N = number of periods • 1,000(1.05) ⁴ = 1,215.51 6 Chapter 1 Introduction to Corporate Finance FI 311 Gregory Sabin Chapter 4 Intro: The Time Value of Money FI 311 Elizabeth Booth Compounding Compounding = The ability of an asset to generate earnings, which are then reinvested in order to generate their own earnings. In other words, compounding refers to generating earnings from previous earnings. Also known as "compound interest". Compound interest means that interest paid on a loan or investment is periodically added to the principal. The result is that interest is earned on interest as well as principal. 7 Chapter 1 Introduction to Corporate Finance FI 311 Gregory Sabin Chapter 4 Intro: The Time Value of Money FI 311 Elizabeth Booth Assumptions: Compounding 1 x per year (simple interest) R = 10% Time Period: 1 2 3 … N Initial Value 100...
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This note was uploaded on 11/09/2011 for the course FI 311 taught by Professor Booth during the Fall '06 term at Michigan State University.

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Chapter_4_Fall2011_s - 1 Chapter 1 Introduction to...

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