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• 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 10year present value is
lower than the 5year 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.
 Fall '14

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