Time Value of Money: Future Value Present Value Rates of Return Amortization

7-1
CHAPTER 7
Time Value of Money
Future value
Present value
Rates of return
Amortization
Copyright © 2002 by Harcourt, Inc. All rights reserved.
7-2
Time lines show timing of cash flows.
0 1 2 3
i%
CF0 CF1 CF2 CF3
Tick marks at ends of periods, so Time 0

is today; Time 1 is the end of Period 1;
or the beginning of Period 2.
7-3
Time line for a $100 lump sum due at

the end of Year 2.
0 1 2 Year
i%
100

7-4
Time line for an ordinary annuity of

$100 for 3 years.
0 1 2 3
i%
100 100 100

7-5
Time line for uneven CFs -$50 at t = 0

and $100, $75, and $50 at the end of
Years 1 through 3.
0 1 2 3
i%
-50 100 75 50

7-6
What’s the FV of an initial $100 after 3

years if i = 10%?
0 1 2 3
10%
100 FV = ?
Finding FVs is compounding.

7-7
After 1 year:
FV1 = PV + INT1 = PV + PV(i)
= PV(1 + i)
= $100(1.10)
= $110.00.
After 2 years:
FV2 = PV(1 + i)2
= $100(1.10)2
= $121.00.
7-8
After 3 years:
FV3 = PV(1 + i)3

= $100(1.10)3
= $133.10.
In general,
FVn = PV(1 + i)n.

7-9
Four Ways to Find FVs
Solve the equation with a regular

calculator.
Use tables.
Use a financial calculator.
Use a spreadsheet.

7 - 10
Financial Calculator Solution
Financial calculators solve this

equation:
FVn = PV(1 + i)n.
There are 4 variables. If 3 are

known, the calculator will solve
for the 4th.
7 - 11
Here’s the setup to find FV:
INPUTS 3 10 -100 0
N I/YR PV PMT FV
OUTPUT 133.10
Clearing automatically sets everything

to 0, but for safety enter PMT = 0.
Set: P/YR = 1, END
7 - 12
What’s the PV of $100 due in 3 years if

i = 10%?
Finding PVs is discounting, and it’s

the reverse of compounding.
0 1 2 3
10%
PV = ? 100

7 - 13
Solve FVn = PV(1 + i )n for PV:
FVn
PV = (1 + i)n = FVn ( 1+i)
1 n
.
PV = $100 ( 1
1.10 ) = $100(PVIF
3
i,n)
= $100(0.7513) = $75.13.

7 - 14
INPUTS 3 10 0 100
N I/YR PV PMT FV
OUTPUT -75.13
Either PV or FV must be negative. Here

PV = -75.13. Put in $75.13 today, take
out $100 after 3 years.
7 - 15
If sales grow at 20% per year, how long

before sales double?
Solve for n:
FVn = $1(1 + i)n;
n
$2 = $1(1.20)
Use calculator to solve, see next slide.

7 - 16
INPUTS 20 -1 0 2
N I/YR PV PMT FV
OUTPUT 3.8
Graphical Illustration:
FV
2
3.8
1
0 Year
1 2 3 4
7 - 17
What’s the difference between an

ordinary annuity and an annuity due?
Ordinary Annuity
0 1 2 3
i%
PMT PMT PMT

Annuity Due
0 1 2 3
i%
PMT PMT PMT

7 - 18
What’s the FV of a 3-year ordinary

annuity of $100 at 10%?
0 1 2 3
10%
100 100 100

110
121
FV = 331

7 - 19
INPUTS 3 10 0 -100
N I/YR PV PMT FV
OUTPUT 331.00
Have payments but no lump sum PV,

so enter 0 for present value.

7 - 20
What’s the PV of this ordinary annuity?
0 1 2 3
10%
100 100 100

90.91
82.64
75.13
248.68 = PV
7 - 21
INPUTS 3 10 100 0
N I/YR PV PMT FV
OUTPUT -248.69
Have payments but no lump sum FV,

so enter 0 for future value.

7 - 22
Find the FV and PV if the

annuity were an annuity due.
0 1 2 3
10%
100 100 100

7 - 23
Switch from “End” to “Begin.”

Then enter variables to find
PVA3 = $273.55.
INPUTS 3 10 100 0
N I/YR PV PMT FV
OUTPUT -273.55
Then enter PV = 0 and press FV to find

FV = $364.10.
7 - 24
What is the PV of this uneven cash

flow stream?
0 1 2 3 4
10%
100 300 300 -50

90.91
247.93
225.39
-34.15
530.08 = PV
7 - 25
Input in “CFLO” register:

CF0 = 0
CF1 = 100
CF2 = 300
CF3 = 300
CF4 = -50
Enter I = 10, then press NPV button to
get NPV = $530.09. (Here NPV = PV.)
7 - 26
What interest rate would cause $100 to

grow to $125.97 in 3 years?
$100 (1 + i )3 = $125.97.
INPUTS 3 -100 0 125.97

N I/YR PV PMT FV
OUTPUT 8%

7 - 27
The Power of Compound Interest
A 20-year old student wants to start

saving for retirement. She plans to
save $3 a day. Every day, she puts
$3 in her drawer. At the end of the
year, she invests the accumulated
savings ($1,095) in an online stock
account. The stock account has an
expected annual return of 12%.

7 - 28
How much money by the age of 65?
INPUTS 45 12 0 -1095
N I/YR PV PMT FV
OUTPUT 1,487,261.89
If she begins saving today, and

sticks to her plan, she will have
$1,487,261.89 by the age of 65.
7 - 29
How much would a 40-year old

investor accumulate by this method?
INPUTS 25 12 0 -1095
N I/YR PV PMT FV
OUTPUT 146,000.59
Waiting until 40, the investor will only

have $146,000.59, which is over $1.3
million less than if saving began at
20. So it pays to get started early.
7 - 30
How much would the 40-year old

investor need to save to accumulate as
much as the 20-year old?
INPUTS 25 12 0 1487261.89
N I/YR PV PMT FV
OUTPUT -11,154.42
The 40-year old investor would have to

save $11,154.42 every year, or $30.56
per day to have as much as the
investor beginning at the age of 20.
7 - 31
Will the FV of a lump sum be larger or
smaller if we compound more often,
holding the stated I% constant? Why?
LARGER! If compounding is more

frequent than once a year--for
example, semiannually, quarterly,
or daily--interest is earned on interest
more often.

7 - 32
0 1 2 3
10%
100 133.10
Annually: FV3 = $100(1.10)3 = $133.10.
0 1 2 3
0 1 2 3 4 5 6
5%
100 134.01
Semiannually: FV6 = $100(1.05)6 = $134.01.
7 - 33
We will deal with 3 different

rates:
iNom = nominal, or stated, or

quoted, rate per year.
iPer = periodic rate.
effective annual
EAR = EFF% = .
rate

7 - 34
iNom is stated in contracts. Periods

per year (m) must also be given.
Examples:
 8%; Quarterly
 8%, Daily interest (365 days)

7 - 35
Periodic rate = iPer = iNom/m, where m

is number of compounding periods
per year. m = 4 for quarterly, 12 for
monthly, and 360 or 365 for daily
compounding.
Examples:
8% quarterly: iPer = 8%/4 = 2%.
8% daily (365): iPer = 8%/365 =
0.021918%.
7 - 36
 Effective Annual Rate (EAR = EFF%):
The annual rate that causes PV to grow
to the same FV as under multi-period
compounding.
Example: EFF% for 10%, semiannual:
FV = (1 + iNom/m)m
= (1.05)2 = 1.1025.
EFF% = 10.25% because
(1.1025)1 = 1.1025.
Any PV would grow to same FV at
10.25% annually or 10% semiannually.
7 - 37
An investment with monthly

payments is different from one with
quarterly payments. Must put on
EFF% basis to compare rates of
return. Use EFF% only for
comparisons.
Banks say “interest paid daily.”
Same as compounded daily.

7 - 38
How do we find EFF% for a nominal
rate of 10%, compounded
semiannually?
EFF = 1 + (
iNom m
m
–1 )
=(1 + 0.10 ) – 1.0
2
2
= (1.05)2 – 1.0
= 0.1025 = 10.25%.
Or use a financial calculator.
7 - 39
EAR = EFF% of 10%
EARAnnual = 10%.
EARQ = (1 + 0.10/4)4 – 1 = 10.38%.
EARM = (1 + 0.10/12)12 – 1 = 10.47%.
EARD(365) = (1 + 0.10/365)365 – 1 = 10.52%.

7 - 40
Can the effective rate ever be equal to

the nominal rate?
Yes, but only if annual compounding

is used, i.e., if m = 1.
If m > 1, EFF% will always be greater
than the nominal rate.

7 - 41
When is each rate used?
iNom: Written into contracts, quoted

by banks and brokers. Not
used in calculations or shown
on time lines.

7 - 42
iPer: Used in calculations, shown on

time lines.
If iNom has annual compounding,

then iPer = iNom/1 = iNom.

7 - 43
EAR = EFF%: Used to compare

returns on investments
with different payments
per year.
(Used for calculations if and only if

dealing with annuities where
payments don’t match interest
compounding periods.)
7 - 44
FV of $100 after 3 years under 10%

semiannual compounding? Quarterly?
mn

FVn = PV 1 +
iNom
 .
 m
2x3
FV3S 
= $100 1 +
0.10

 2 
= $100(1.05)6 = $134.01.
FV3Q = $100(1.025)12 = $134.49.
7 - 45
What’s the value at the end of Year 3
of the following CF stream if the
quoted interest rate is 10%,
compounded semiannually?
0 1 2 3 4 5 6 6-mos.
5% periods
100 100 100

7 - 46
Payments occur annually, but

compounding occurs each 6
months.
So we can’t use normal annuity
valuation techniques.

7 - 47
1st Method: Compound Each CF
0 1 2 3 4 5 6
5%
100 100 100.00

110.25
121.55
331.80
FVA3 = $100(1.05)4 + $100(1.05)2 + $100

= $331.80.
7 - 48
2nd Method: Treat as an Annuity
Could you find FV with a

financial calculator?
Yes, by following these steps:
a. Find the EAR for the quoted rate:

2
EAR = ( 0.10
1+ 2 ) – 1 = 10.25%.
7 - 49
Or, to find EAR with a calculator:
NOM% = 10.
P/YR = 2.
EFF% = 10.25.

7 - 50
b. The cash flow stream is an annual

annuity. Find kNom (annual) whose
EFF% = 10.25%. In calculator,
EFF% = 10.25
P/YR = 1
NOM% = 10.25
c.
INPUTS 3 10.25 0 -100

N I/YR PV PMT FV
OUTPUT 331.80

7 - 51
What’s the PV of this stream?
0 1 2 3
5%
100 100 100
90.70
82.27
74.62
247.59
7 - 52
Amortization
Construct an amortization schedule

for a $1,000, 10% annual rate loan
with 3 equal payments.

7 - 53
Step 1: Find the required annual

payments.
0 1 2 3
10%
-1,000 PMT PMT PMT
INPUTS 3 10 -1000 0
N I/YR PV PMT FV
OUTPUT 402.11

7 - 54
Step 2: Find the interest paid in

Year 1.
INTt = Beg balt (i)
INT1 = $1,000(0.10) = $100.
Step 3: Find repayment of principal

in Year 1.
Repmt = PMT – INT
= $402.11 – $100
= $302.11.
7 - 55
Step 4: Find ending balance after

Year 1.
End bal = Beg bal – Repmt

= $1,000 – $302.11 = $697.89.
Repeat steps 2-4 for Years 2 and 3

to complete the amortization table.

7 - 56
BEG PRIN END

YR BAL PMT INT PMT BAL
1 $1,000 $402 $100 $302 $698

2 698 402 70 332 366
3 366 402 37 366 0
TOT 1,206.34 206.34 1,000
Interest declines. Tax implications.

7 - 57
$
402.11
Interest
302.11
Principal Payments
0 1 2 3
Level payments. Interest declines because
outstanding balance declines. Lender earns
10% on loan outstanding, which is falling.
7 - 58
Amortization tables are widely used--

for home mortgages, auto loans,
business loans, retirement plans, etc.
They are very important!
Financial calculators (and
spreadsheets) are great for setting up
amortization tables.

Time Value of Money: Future Value Present Value Rates of Return Amortization

Hochgeladen von

Dokumentinformationen

Originaltitel

Copyright

Verfügbare Formate

Dieses Dokument teilen

Dokument teilen oder einbetten

Freigabeoptionen

Stufen Sie dieses Dokument als nützlich ein?

Sind diese Inhalte unangemessen?

Copyright:

Verfügbare Formate

Time Value of Money: Future Value Present Value Rates of Return Amortization

Hochgeladen von

Copyright:

Verfügbare Formate

7-1

Time lines show timing of cash flows.

CF0 CF1 CF2 CF3

Tick marks at ends of periods, so Time 0

Time line for a $100 lump sum due at

Copyright © 2002 by Harcourt, Inc. All rights reserved.

Time line for an ordinary annuity of

100 100 100

Copyright © 2002 by Harcourt, Inc. All rights reserved.

Time line for uneven CFs -$50 at t = 0

Copyright © 2002 by Harcourt, Inc. All rights reserved.

What’s the FV of an initial $100 after 3

Finding FVs is compounding.

FV3 = PV(1 + i)3

FVn = PV(1 + i)n.

Copyright © 2002 by Harcourt, Inc. All rights reserved.

Four Ways to Find FVs

Solve the equation with a regular

Copyright © 2002 by Harcourt, Inc. All rights reserved.

Financial Calculator Solution

Financial calculators solve this

FVn = PV(1 + i)n.

There are 4 variables. If 3 are

Here’s the setup to find FV:

Clearing automatically sets everything

What’s the PV of $100 due in 3 years if

Finding PVs is discounting, and it’s

Copyright © 2002 by Harcourt, Inc. All rights reserved.

Solve FVn = PV(1 + i )n for PV:

Copyright © 2002 by Harcourt, Inc. All rights reserved.

Financial Calculator Solution

Either PV or FV must be negative. Here

If sales grow at 20% per year, how long

Use calculator to solve, see next slide.

Copyright © 2002 by Harcourt, Inc. All rights reserved.

What’s the difference between an

PMT PMT PMT

PMT PMT PMT

What’s the FV of a 3-year ordinary

100 100 100

Copyright © 2002 by Harcourt, Inc. All rights reserved.

Financial Calculator Solution

Have payments but no lump sum PV,

Copyright © 2002 by Harcourt, Inc. All rights reserved.

What’s the PV of this ordinary annuity?

100 100 100

Have payments but no lump sum FV,

Copyright © 2002 by Harcourt, Inc. All rights reserved.

Find the FV and PV if the

100 100 100

Copyright © 2002 by Harcourt, Inc. All rights reserved.

Switch from “End” to “Begin.”

Then enter PV = 0 and press FV to find

What is the PV of this uneven cash

100 300 300 -50

Input in “CFLO” register:

What interest rate would cause $100 to

INPUTS 3 -100 0 125.97

Copyright © 2002 by Harcourt, Inc. All rights reserved.

The Power of Compound Interest

A 20-year old student wants to start

Copyright © 2002 by Harcourt, Inc. All rights reserved.

How much money by the age of 65?