Effects of Compounding Simple interest – earn interest on principal only Compound interest – earn interest on principal and reinvested interest Present Values The Basic Pv Equation – Refresher. = Discount Rate Finding the Number of Periods CLOSING – SUMMARY (CHAPTER V) QUIZ
18 C.Stricker – Finance Review CHAPTER VI DISCOUNT CASH FLOW VALUATION Key Concepts & Skills Be able to compute the future value and present value of multiple cash flows• Be able to compute loan payments and find the interest rate on a loan• Understand how loans are amortized or paid off Understand how interest rates are quoted and misquoted Chapter Outline Future and Present Values of Multiple Cash Flows Valuing Level Cash Flows: Annuities and Perpetuities Comparing Rates: The Effect of Compounding
19 C.Stricker – Finance Review Loan Types and Loan Amortization Summary and Conclusions Anunuities & Perpetuities Annuity – finite series of equal payments that occur at regular intervals If the first payment occurs at the end of the period, it is called an ordinary annuity If the first payment occurs at the beginning of the period, it is called an annuity due Perpetuity – infinite series of equal payments Annuities & Perpetuities – Basic Formulas Annuities & the Calculator: You can use the PMT key on the calculator for the equal payment The sign convention still holds Ordinary annuity versus annuity due You can switch your calculator between the two types by using the 2 nd BGN 2 nd Set on the TIBA- II Plus If you see “BGN” or “Begin” in the display of your calculator, you have it set for an annuity due Most problems are ordinary annuities Finding the Rate on the Finacial Calculator: Suppose you borrow $10,000 from your parents to buy a car. You agree to pay $207.58 per month for 60 months. What is the monthly interest rate? Calculator Approach: Sign convention matters!!! 60 N 10,000 PV -207.58 PMT CPT I/Y = .75% Annuity – Finding the Rate Without a Financial Calculator Trial and Error Process: 1.Choose an interest rate and compute the PV of the payments based on this rate2.Compare the computed PV with the actual loan amount
20 C.Stricker – Finance Review Growing perpetuity formula: Growing Annuity Growing annuities have a finite number of growing cash flows Growing annuity formula: Effective Annual Rate (EAR) This is the actual rate paid (or received) after accounting for compounding that occurs during the year If you want to compare two alternative investments with different compounding periods, you need to compute the EAR for both investments and then compare the EAR’s. Annual Percentage Rate This is the annual rate that is quoted by law By definition APR = period rate
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