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Time Value of Money

# Time Value of Money - Time Value of Money ECON 3381 A Hales...

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Time Value of Money ECON 3381 A. Hales

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Time Value of Money A dollar today is worth more than a dollar to be received in  the future because if you had it now you could invest it and  earn interest.   Time Value of Money has many applications, including  saving to achieve a goal, planning for retirement,  valuing  stocks and bonds, setting up loan payment schedules, and  making corporate decisions regarding new plant and  equipment.   It is important that you understand the concepts behind  time value of money but it is equally important that you are  able to perform the required calculations.  In this class,  when possible, you will be asked to complete calculations  by hand and you will be allowed to verify your answers  using a financial calculator.
Important terms Time Line Important graphical tool used to show  the timing of cash flows Present Value (PV) The value today of a future cash flow or  series of cash flows Future Value (FV) The amount to which a cash or series of  cash flows will grow over a given period  of time when compounded at a given  interest rate

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Important terms Interest (I):  interest rate earned per  year Simple-occurs when interest is not  earned on prior periods’ interest Compound-occurs when interest is  earned on prior periods’ interest Compounding-the arithmetic process of  going from present to future values when  compound interest is applied Discounting-the arithmetic process of  going from future to present values when  compound interest is applied; the reverse
Finding Future Value (Compounding) Formula Approach: Financial Calculator Approach: N N I PV FV ) 1 ( + = N I/YR PV PMT FV

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Example & Class Exercise 1: Find the following values using the equations.  Compounding occurs  annually. a. The future value of an initial \$500 compounded for 1 year at 6%. b.  The future value of an initial \$500 compounded for 2 years at 6%.
Simple versus Compound interest Future Value under simple interest What is the difference between the  future value of \$100 after 5 years at  10% simple interest and 10%  compound interest?

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