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The Time Value of Money Chapter 5

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LEARNING OBJECTIVES 1. Explain the mechanics of compounding when invested. 2. Present value and future value. 3. Ordinary annuity and its future value. 4. An ordinary annuity and an annuity due. 5. Non-annual future or present value of a sum . 6. Determine the present value of a perpetuity.

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**Power of time of value of money**

History of Interest Rates $1000 ( )400 = ?

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**Power of time value of money**

Money Angles: by Andrew Tobias. 1. Chessboard with the King 2. Manhattan

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**Terms Compound Interest Future value and Present Value Annuities**

Annuities Due Amortized Loans Compound Interest with Non-annual Periods Present Value of an Uneven Stream· Perpetuities

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**COMPOUND INTEREST FV1=PV (1+i) (5-1)**

Where FV1=the future value of the investment at the end of one year i=the annual interest (or discount) rate PV=the present value, or original amount invested at the beginning of the first year

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Future value 1. Simple compounding 2. Complex compounding

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Future value

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FV1=PV (1+i) =$100(1+0.06) =$100(1.06) =$106

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Compound twice a year

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**Compound four times a year**

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Compound 12 times a year

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Compound 360 times a year

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**Continuous compounding**

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**Illustration of Compound Interest Calculations**

Year Beginning Value Interest Earned Ending Value $ $ $106.00

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**Future value and future value interest factor**

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FVn=PV(FVIFi,n)

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**FVIFi,n or the Compound Sum of $1**

Table 5-2 FVIFi,n or the Compound Sum of $1 N % % % % % % % % % %

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PV=$300, Vn=$774; i=9 % N= ？

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**PV=$100; FVn=$179.10; n=10 years. I= ?**

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PRESENT VALUE

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FV10=$500, n=10, i=6 % PV = ?

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**(PVIF i, n) (PVIF i, n) = 1/(1+i)**

present-value interest factor for I and n (PVIF i, n), (PVIF i, n) = 1/(1+i)

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**Present value FV10 =$1,500 N= 10 years discount rate= 8 %**

PV=$1500(0.463) =$694.50

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**PVIFi,n or the Present Value of $1**

Table 5-3 PVIFi,n or the Present Value of $1 N % % % % % % % % % %

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**ANNUITIES Annuity: equal annual cash flows.**

Ordinary annuity: at the end of each period. Annuity due: at the beginning of each eriod.

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Table 5-4 Illustration of a Five-Year $500 Annuity Compounded at 6 percent YEAR DOLLAR DEPOSITS AT END OF YEAR $500.00 530.00 562.00 595.50 631.00 Future value of the annuity $2,818.50

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Ordinary annuity FVIFAk,n = [(1/k) ( (1+ k)n – 1)]

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**Present value of an Annuity**

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Table 5-6 Illustration of a Five-Year $500 Annuity Discounted to the Present at 6 percent YEAR Dollars received at the the end of year $471.50 445.00 420.00 396.00 373.50 PV annuity $2,106.00

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**PVIFAK,n = (1/k) [( 1 – 1/(1+k)n]**

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**PVIFi,n or the Present Value of an Annuity of $1**

Table 5-7 PVIFi,n or the Present Value of an Annuity of $1 N % % % % % % % % % %

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**n=10 years, I=5 percent, and current PMT=$1,000**

PV= $1,000(7.722) = $7,722

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**PMT Annuity: $5,000, n =5 years, i=8 percent, PMT:?**

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AMORTIZED LOANS

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**Loan Amortization Schedule Involving a $6,000 Loan at 15 Percent to Be Repaid in Four Years**

Year Annuity Interest Portion Repayment of Outstanding Of The Annuity The Principal Loan Balance Portion Of The After The An- Annuity nuity Payment $2, $ $1, $4,798.42 , , ,416.60 , , ,827.51 , ,827.51

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**ANNUITIES DUE FVn (annuity due)=PMT(FVIFA I,n)(1+I) (5-10)**

FV5=$500(FVIFA5%,5)(1+0.06) =$500(5.637)(1.06) =$2,987.61 from $2,106 to $2,232.36, PV=$500(PVIFA6%,5)(1+0.06) =$500(4.212)(1.06) =$2,232.36

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**End of year principal(5)**

End year Loan payment (1) Beginning principal (2) payments End of year principal(5) [(2) －(4)] Interest(3) [0.1 × (2)] Principal(4) [(1) － (3)] 1 $ $ $600.00 $ $ 2 $470.73 $ $ 3 $328.53 $ $ 4 $172.10 $

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**The Value of $100 Compounded at Various Intervals FOR 1 YEAR AT i PERCENT**

Compounded annually $ $ $ $115.00 Compounded semiannually Compounded quarterly Compounded monthly Compounded weekly (52) Compounded daily (365)

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**PRESENT VALUE OF AN UNEVEN STREAM**

YEAR CASH FLOW YEAR CASH FLOW $

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**Present value of $500 received at the end of one year**

= $500(0.943) = $471.50 2. Present value of $200 received at the end of tree years = $200(0.890) = 3. Present value of a $400 outflow at the end of three years = -400(0.840) = 4. (a) Value at the end of year 3 and a $500 annuity, years 4 through 10 = $500 (5.582) = $2,791.00 (b) Present value of $2, received at the end of year 3 = 2,791(0.840) = 2,344.44 5. Total present value = $2,657.94

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**Quiz 1 Warm up Quiz. Terms:**

: n = 5, m = 4, I =12 percent, and PV =$100 solve for fv

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Quiz 2 What is the present value of an investment involving $200 received at the end of years 1 through 4, a $300 cash outflow at the end of year 5 to 8, and $500 received at the end of years 9 through 10, given a 5 percent discount rate?

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Quiz 3 A 25 year-old graduate has his $50,000 salary a year. How much will he get when he reaches to 60 (35 years later)year-old with a value rate of 8%(annual compounding). The graduate will have his $80,000 salary at age of 30. How much will he get when he reaches to his age of 60(30 years later) with the value rate of 8%(semi-annual compounding).

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Quiz 4 The graduate will have his $100,000 salary at age of 40. How much will he get when he reaches to his age of 60(20 years later) with the value rate of 12%(quarterly-annual compounding). Compute the future value from 25-30/30-40/40-60 year old with the same rate and the compounding rate.

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PERPETUITIES $500 perpetuity discounted back to the present at 8 percent? PV = $500/0.08 = $6,250

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**Power of time of value of money**

History of Interest Rates $1000 ( )400 = ?

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**Power of time value of money**

Money Angles: by Andrew Tobias. Chessboard with the King Manhattan

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2 20 107 1 106 13 19 21 25 22/24 3 12 14 23 4 11 15 26 27 30 5 7 6 9 16 18 28 104 29 8/17 32/109 100 99 105 108 31 34 40/42 41 98 68 93 90/92 91 81 80.

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