44718984 what is the effect of compounding simple

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Unformatted text preview: rowth Suppose your company expects to Suppose increase unit sales of widgets by 15% per year for the next 5 years. If you currently sell 3 million widgets in one year, how many widgets do you expect to sell in 5 years? years? FV = 3,000,000(1.15)5 = 6,034,072 11 Quick Quiz – Part I What is the difference between simple interest What and compound interest? and Suppose you have $500 to invest and you Suppose believe that you can earn 8% per year over the next 15 years. next How much would you have at the end of 15 years How using compound interest? using How much would you have using simple interest? 12 Present Values How much do I have to invest today to have some How amount in the future? amount FV = PV(1 + r)t Rearrange to solve for PV = FV / (1 + r)t When we talk about discounting, we mean finding the When present value of some future amount. present When we talk about the “value” of something, we are When talking about the present value unless we specifically indicate that we want the future value. indicate 13 Present Value – One Period Present Example Example Suppose you need $10,000 in one year for the down Suppose payment on a new car. If you can earn 7% annually, how much do you need to invest today? how PV = 10,000 / (1.07)1 = 9,345.79 Calculator 1N 7 I/Y 10,000 FV CPT PV = -9,345.79 14 Present Values – Example 2 You want to begin saving for your You daughter’s college education and you estimate that she will need $150,000 in 17 years. If you feel confident that you can earn 8% per year, how much do you need to invest today? to PV = 150,000 / (1.08)17 = 40,540.34 15 Present Values – Example 3 Your parents set up a trust fund for you 10 Your years ago that is now worth $19,671.51. If the fund earned 7% per year, how much did your parents invest? did PV = 19,671.51 / (1.07)10 = 10,000 16 Present Value – Important Present Relationship I Relationship For a given interest rate – the longer the For time period, the lower the present value time What is the present value of $500 to be What received in 5 years? 10 years? The discount rate is 10% rate 5 years: PV = 500 / (1.1)5 = 310.46 10 years: PV = 500 / (1.1)10 = 192.77 17 Present Value – Important Present Relationship II Relationship For a given time period – the higher the For interest rate, the smaller the present value value What is the present value of $500 received What in 5 years if the interest rate is 10%? 15%? in • Rate = 10%: PV = 500 / (1.1)5 = 310.46 • Rate = 15%; PV = 500 / (1.15)5 = 248.59 18 Quick Quiz – Part II What is the relationship between present value What and future value? and Suppose you need $15,000 in 3 years. If you Suppose can earn 6% annually, how much do you need to invest today? invest If you could invest the money at 8%, would you If have to invest more or less than at 6%? How much? much? 19 The Basic PV Equation The Refresher Refresher PV = FV / (1 + r)t There are four parts to this equation PV, FV, r and t If we know any three, we c...
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This document was uploaded on 10/01/2013.

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