16 simple interest and compound interest cont simple

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16 Simple Interest and Compound Interest (cont.) Simple Interest – Interest earned = 5% of $500 = .05×500 = $25 per year – Total interest earned = $25×2 = $50 – Balance in your savings account: = Principal + accumulated interest = $500 + $50 = $550
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9 17 Simple Interest and Compound Interest (cont.) Compound interest – Interest earned in Year 1 = 5% of $500 = $25 – Interest earned in Year 2 = 5% of ($500 + accumulated interest) = 5% of ($500 + 25) = .05×525 = $26.25 – Balance in your savings account: = Principal + interest earned = $500 + $25 + $26.25 = $551.25 18 How you can compare amounts in different time periods? One can adjust values from different time periods using an interest rate. Remember, one CANNOT compare numbers in different time periods without first adjusting them using an interest rate.
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10 19 What is Time Value? In other words, “a dollar received today is worth more than a dollar to be received tomorrow” That is because today’s dollar can be invested so that we have more than one dollar tomorrow 20 Why net present value (NPV) is superior to accounting rate of return (ARR) and payback period (PP) NPV fully addresses The timing of the cash flows
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11 21 Net Present Value Net present value method (also known as discounted cash flow method) is a popular capital budgeting technique that takes into account the time value of money. It uses net present value of the investment project as the base to accept or reject a proposed investment in projects like purchase of new equipment, purchase of inventory, expansion or addition of existing plant assets and the installation of new plants etc. 22 Net Present Value Takes into account the fact that money values change with time How much would you need to invest today to earn x amount in x years time? Value of money is affected by interest rates NPV helps to take these factors into consideration Shows you what your investment would have earned in an alternative investment regime
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12 23 What is the NPV Net present value (NPV): Net present value is the difference between the present value of cash inflows and the present value of cash outflows that occur as a result of undertaking an investment project. It may be positive, zero or negative. These three possibilities of net present value are briefly explained below: Positive NPV: Zero NPV: Negative NPV: 24 What is the NPV Positive NPV: If present value of cash inflows is greater than the present value of the cash outflows, the net present value is said to be positive and the investment proposal is considered to be acceptable. Zero NPV: If present value of cash inflow is equal to present value of cash outflow, the net present value is said to be zero and the investment proposal is considered to be acceptable. Negative NPV: If present value of cash inflow is less than present value of cash outflow, the net present value is said to be negative and the investment proposal is rejected.
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13 25 What is the NPV The summary of the concept explained so far is given below: 26 What is Time Value?
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