Chapter 5  The Time Value of Money
The Time Value of Money
Compounding and Discounting Single Sums
We know that receiving $1 today is worth
more
than $1 in the future.
This is due to
opportunity costs
.
The opportunity cost of receiving $1 in the future is the interest
we could have earned if we
had received the $1 sooner.
If we can measure this opportunity cost, we can:
Translate $1 today into its equivalent in the future
(compounding).
Translate $1 in the future into its equivalent today
(discounting).
Compound Interest and Future Value
Future Value  single sums
If you deposit $100 in an account earning 6%, how much would you have in the
account after 1 year?
Calculator Solution:
P/Y = 1
I = 6
N = 1
PV =
100
FV =
$106
Mathematical Solution:
FV = PV (FVIF
i, n
)
FV = 100 (FVIF
.06, 1
)
(use FVIF table, or)
FV = PV (1 + i)
n
FV = 100 (1.06)
1
=
$106
Future Value  single sums
If you deposit $100 in an account earning 6%, how much would you have in the
account after 5 years?
Calculator Solution:
P/Y = 1
I = 6
N = 5
PV =
100
FV =
$133.82
Future Value  single sums
If you deposit $100 in an account earning 6%, how much would you have in the
account after 5 years?
Calculator Solution:
P/Y = 1
I = 6
N = 5
PV =
100
FV =
$133.82
Future Value  single sums
If you deposit $100 in an account earning 6%, how much would you have in the
account after 5 years?
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 Spring '11
 sadzd
 Time Value Of Money, Future Value

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