lecture_chap05_06A

15 important relationship ii continued formula

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Unformatted text preview: ach • 5 years: N = 5; I/Y = 10; FV = 500 CPT PV = -310.46 • 10 years: N = 10; I/Y = 10; FV = 500 CPT PV = -192.77 • Notice that the 10-year present value is lower than the 5-year present value Present Value – Important Relationship II • For a given time period – the higher the interest rate, the smaller the present value • What is the present value of $500 received in 5 years if the interest rate is 10%? 15%? Important Relationship II continued • Formula Approach • Rate = 10%: PV = 500 / (1.1)5 = 310.46 • Rate = 15%; PV = 500 / (1.15)5 = 248.59 • Calculator Approach • Rate = 10%: N = 5; I/Y = 10; FV = 500 CPT PV = -310.46 • Rate = 15%; N = 5; I/Y = 15; FV = 500 CPT PV = -248.59 • Notice that the present value with the 15% interest rate is lower than the present value with the 10% interest rate Workshop #2 • Suppose you need $15,000 in 3 years. If you can earn 6% annually, how much do you need to invest today? • Answer = 12,594 • If you could invest the money at 8%, would you have to invest more or less than your answer above? How much? • Answer = Would be less. 11,907 The Basic PV Equation Refresher • PV = FV / (1 + r)t • There are four parts to this equation • PV, FV, r and t • If we know any three, we can solve for the fourth • If you are using a financial calculator, the calculator views cash inflows as positive numbers and cash outflows as negative numbers. Be sure and remember the sign convention or you will receive an error when solving for r or t Discount Rate – 5.3 • Often we will want to know what the implied interest rate is in an investment • Rearrange the basic PV equation and solve for r • FV = PV(1 + r)t • r = (FV / PV)1/t – 1 Discount Rate – Example 1 • You are looking at an investment that will pay $1200 in 5 years if you invest $1000 today. What is the implied rate of interest? • r = (1200 / 1000)1/5 – 1 = .03714 = 3.714% • Calculator – the sign convention matters!!! • • • • N=5 PV = -1000 (you pay 1000 today) FV = 12...
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This document was uploaded on 02/06/2014.

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