79 13 13 present values example 2 you want to begin

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Unformatted text preview: ter’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 14 14 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 15 15 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 16 16 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 17 17 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? 18 18 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 can solve for the fourth If you are using a financial calculator, be sure If and remember the sign convention or you will receive an error (or a nonsense answer) when solving for r or t solving 19 19 Discount Rate Often we will want to know what the implied Often interest rate is in an investment interest Rearrange the basic PV equation and solve for r FV = PV(1 + r)t r = (FV / PV)1/t – 1 If you are using formulas, you will want to make If use of both the yx and the 1/x keys use 20 20 Discount Rate – Example 1 You are looking at an investment that will pay You $1,200 in 5 years if you invest $1,000 today. What is the implied rate of interest? What r = (1,200 / 1,000)1/5 – 1 = .03714 = 3.714% Calculator –...
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This document was uploaded on 04/02/2014.

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