Chapter 5_S - Chapter 5: Introduction to Valuation: The...

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1 Chapter 5: Introduction to Valuation: The Time Value of Money Future Value and Compounding Present Value and Discounting More on Present and Future Values
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2 Basic Definitions Time value of money – a dollar in hand today is worth more than a dollar promised at some time in the future. Future Value – the amount an investment is worth after one or more periods (later money on a time line). Present Value – the current value of future cash flows discounted at the appropriate discount rate (earlier money on a time line). Interest rate – “exchange rate” between earlier money and later money.
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3 Future Value – Example 1 Suppose you invest $1,000 for one year at 5% per year. What is the future value in one year? Interest = 1,000(.05) = 50 Value in one year = principal + interest = 1,000 + 50 = 1,050 Future Value (FV) = 1,000(1 + .05) = 1,050 Suppose you leave the money in for another year. How much will you have two years from now? FV = 1,000(1.05)(1.05) = 1,000(1.05) 2 = 1,102.50
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4 Future Values: General Formula FV = PV(1 + r) t FV = future value PV = present value r = period interest rate, expressed as a decimal t = number of periods Future value interest factor = (1 + r) t or FVIF(r, t) = (1 + r) t
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5 Effects of Compounding Simple interest Compound interest Consider the previous example FV with simple interest = FV with compound interest = What does the difference stands for?
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6 Calculator Keys Texas Instruments BA-II Plus N = number of periods I/Y = period interest rate P/Y must equal 1 for the I/Y to be the period rate Interest is entered as number of percent, not a decimal
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This note was uploaded on 01/13/2012 for the course FR 403 taught by Professor Hoffman during the Spring '11 term at Central Washington University.

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Chapter 5_S - Chapter 5: Introduction to Valuation: The...

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