finance_mngmt_chap5

finance_mngmt_chap5 - Chapter 5 Introduction to Valuation...

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Chapter 5: Introduction to Valuation: The Time Value of Money 5.1 Future Value and Compounding Future Value – the amount an investment is worth after one or more periods FV = PV(1 + r) t Present Value – Examples: Suppose you invest $1000 for one year at 5% per year. What is the future value in one year? Interest = 1000(.05) = 50 Value in one year = principal + interest = 1000 + 50 = 1050 Future Value (FV) = 1000(1 + .05) = 1050 Suppose you leave the money in for another year. How much will you have two years from now? G’ FV = 1000(1.05)(1.05) = 1000(1.05) 2 = 1102.50 What is the simple interest & compound interest after 2 years? FV with simple interest = 1,000 + 50 + 50 = 1,100 FV with compound interest = 1,102.50 The extra 2.50 comes from the interest of .05(50) = 2.50 earned on the first interest payment Suppose you had a relative deposit $10 at 5.5% interest 200 years ago. How much would the investment be worth today? FV = 10(1.055) 200 = 447,189.84 What is the effect of compounding? Simple interest = 10 + 200(10)(.055) = 120.00 Compounding added $447,069.84 to the value of the investment
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