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FIN301 Chapter 5 all stu

# FIN301 Chapter 5 all stu - Key Vocabulary Time Value of...

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FINA 760 Corporate Finance Farmer School Key Vocabulary 1 Time Value of Money (TVM) Time Lines Compound Interest Compounding Discounting Interest rates Nominal, quoted, stated rate Periodic rate Effective annual rate (EAR)

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FINA 760 Corporate Finance Farmer School Time Value of Money * 2 This is the foundational concept of Finance Theoretical Mathematical Calculator
FINA 760 Corporate Finance Farmer School “Money Makes Money” 3 Money today is worth more than the same amount of money in the future Reason - earn interest on the money “Smart” money vs. “Lazy” money

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FINA 760 Corporate Finance Farmer School 7 “Ancient Wonders of the World” 4
FINA 760 Corporate Finance Farmer School What is the “8th” Wonder of the World? 5 3 elements - 1. Absolute amount of return (interest rate – higher is better at a given amount of risk) 2. Number of times it is compounded (more is better) 3. Absolute amount of time (more is better)

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FINA 760 Corporate Finance Farmer School 6 Which offer would YOU take? n You graduate from high school and your mother makes you two offers: 1. She will put \$20,000 in a savings account EVERY YEAR until you retire (47 years at 3% per year) 2. She will put \$20,000 in a mutual fund in the first year only (47 years and earns 10%/yr above inflation)
FINA 760 Corporate Finance Farmer School 7 Compare Year \$20,000/yr \$20,000 once 10 20 30 47

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FINA 760 Corporate Finance Farmer School 8 A picture of my cat
FINA 760 Corporate Finance Farmer School Simple vs. Compound Interest 9 Simple Interest Interest on original principal only Compound Interest Interest paid on accumulated value Equals simple interest plus “interest on interest”

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FINA 760 Corporate Finance Farmer School “Types” of Interest 10 Simple Interest Earn interest only on the original balance \$100 deposit at beginning of year earning 5% annually 5% of \$100 for one year is \$5 \$100 x .05 = \$5 End of year 1 = \$105 End of year 2 = \$110 End of year 3 = \$115
FINA 760 Corporate Finance Farmer School “Interest on Interest” 11 Earns “interest” on previous “interest” \$100 deposit earning %5 annually End of year 1 = \$105 \$100 x 5% = \$5.00 End of year 2 = \$110.25 \$105 x 5% = \$5.25 End of year 3 = \$115.76 \$110.25 x 5% = \$5.51

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FINA 760 Corporate Finance Farmer School Compound Interest Compound interest = simple interest + interest on interest All we are interested in is compound interest
FINA 760 Corporate Finance Farmer School Time Lines are your friend 13 Time line - a graphic representation of cash flows

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FINA 760 Corporate Finance Farmer School Time Lines are your friend 14 Time line - a graphic representation of cash flows 0 1 2 3 4 5 6 7 (Periods) 1 = the “end” of period 1 and the “beginning” of period 2
Corporate Finance Farmer School Time Lines are your friend 15 Time line - a graphic representation of cash flows 0 1 2 3 4 5

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FIN301 Chapter 5 all stu - Key Vocabulary Time Value of...

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