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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