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Excel Financial Functions Agenda – Discuss interest and the time value of money – Explore the Excel time value of money functions

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Working with Financial Functions 2 Cost of a loan to the borrower is largely based on three factors: – Principal: amount of money being loaned – Interest: amount added to the principal by the lender Calculated as simple interest or as compound interest – Time required to pay back the loan

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Using Functions to Manage Personal Finances 3 FunctionUse to determine… FV (future value)How much an investment will be worth after a series of monthly payments at some future time PMT (payment)How much you have to spend each month to repay a loan or mortgage within a set period of time PV (present value)Largest loan or mortgage you can afford given a set monthly payment NPER (number of periods)How long it will take to pay off a loan with constant monthly payments RATEDetermines the PERIODIC interest rate CUMIPMTThe cumulative interest paid between two periods CUMPRINCThe cumulative principal paid between two periods IPMT (interest payment)How much of your monthly loan payment is used to pay the interest PPMT (principal payment)How much of your monthly loan payment is used for repaying the principal

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4 Excel Functions are Excel Functions To use them, you must understand the TIME VALUE OF MONEY

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Understanding time value of money 5 Money will increase in value over time if the money is invested and can make more money. If you have $1,000 today, it will be worth more tomorrow if you invest that $1,000 and it earns additional money (interest or some other return on that investment). If you have $1,000 today, it will NOT be worth more tomorrow if you put it in an envelope and hide it in a drawer. Then the time value of money does not apply as an increase. It will most likely decrease in value because of inflation. Of course, you wont lose the whole $1,000 either…

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Introduction to Interest Calculations When you borrow money you pay interest When you loan money, you receive interest When you make a payment – part of the payment is applied to interest – Part of the payment is applied to principal

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Types of Interest Simple interest – Interest is paid only on the principal – Many certificates of deposit work this way Compound interest – Interest is added to the principal each period – Interest is calculated on the principal plus any accrued interest – Compounding can occur on different periods Annually, quarterly, monthly, daily

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Difference between simple and compound interest 8 Assume that you have $1,000 to invest. $1,000 is the present value (PV) of your money. You can invest it and receive simple interest or you can earn compound interest. The money that you have at the end of the time you have invested it is called the future value (FV) of your money.

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Future value of money 9 Simple interest is always calculated on the initial $1,000. 5% interest on $1,000 is $50. Always $50. When interest is paid on not only the principal amount invested, but also on any previous interest earned, this is called compound interest. FV = Principal + (Principal x Interest) = (1000 x.05) = 1000 (1 + i) = PV (1 + i)

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Simple vs. compound interest comparison 10 YearSimple InterestCompound Interest 0$1,000 1$1,050 2$1,100$1, $1,150$1, $1,200$1, $1,250$1, $1,500$1, $2,000$2, $2,500$4, $1,000 Invested at 5% return

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Time Value of Money Functions We are just solving the same equation for a different variable – RATE determines the interest rate – NPER determines the number of periods – PMT determines the payment – PV determines the present value of a transaction – FV determines the future value of a transaction

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Future Value Function 12 ArgumentDescription rateInterest rate per compounding period nperNumber of compounding periods PmtPayment made each compounding period PvPresent value of current amount typeDesignates when payments or deposits are made Type 0 – end of period. Default. Type 1 – beginning of period FV(rate, nper, pmt, [pv], [type])

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Present Value Function 13 ArgumentDescription rateInterest rate per compounding period NperNumber of compounding periods pmtPayment made each period fvFuture value of the amount received today typeDesignates when payments are made Type 0 – end of period. Default. Type 1 – beginning of period PV(rate, nper, pmt, [fv], [type])

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Payment function 14 ArgumentDescription rateInterest rate per compounding period nperNumber of compounding periods pvPresent value fv Future value, residual left over after the loan is completed. Could be a balloon payment. Can be omitted if = 0. typeDesignates when payments are made Type 0 – end of period. Default. Type 1 – beginning of period PMT(rate, nper, pv, [fv], [type])

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The RATE Function Determines the interest rate PER PERIOD based on – The number of periods – The payment – The present value – The future value – The type

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The NPER Function Determines the number of periods based on – The interest rate – The payment – The present value – The future value – The type

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What about if you borrow money? 17 If you borrow money, the lender wants to earn compound money on his/her/its investment. If you borrow $1000 at 10%, then you wont pay back just $1,100 (unless you pay it back at once during the initial time period). You will pay it back compounded. Interest will be calculated each period on your remaining balance.

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Amortization table $1,000 loan, pay $100 year, 5% year interest 18 YearAmount OwedAmount Plus InterestPayment 1$1,000.00$1,050.00$ $950.00$997.50$ $897.50$942.38$ $842.38$884.49$ $784.49$823.72$ $723.72$759.90$ $659.90$692.90$ $592.90$622.54$ $522.54$548.67$ $448.67$471.11$ $371.11$389.66$ $289.66$304.14$ $204.14$214.35$ $114.35$120.07$ $20.07$21.07 Total Paid$1,421.07

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19 What would that same amortization table (also called a schedule) look like if the interest was compounded AFTER you paid, rather than BEFORE you paid? (this is a type 1 on Excel financial functions)

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Amortization table $1,000 loan, pay $100 year, 5% year interest 20 YearAmount OwedPaymentAmount Plus Interest 1$1,000.00$ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $393.54$ $ $308.22$ $ $218.63$ $ $124.55$ $ $25.78 $0.00 Total Paid$1,325.78

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The IPMT and PPMT Functions (Introduction) Use IPMT to calculate the interest applicable to a particular period – Use the initial balance for the present value no matter the period Use PPMT to calculate the principal applicable to a particular period The arguments to both functions are the same

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Interest Payment 22 ArgumentDescription rateInterest rate per compounding period perPeriod for which interest should be calculated. nperNumber of compounding periods pvPresent value fv Future value, residual left over after the loan is completed. Could be a balloon payment. Can be omitted if = 0. typeDesignates when payments are made Type 0 – end of period. Default. Type 1 – beginning of period IPMT(rate, per, nper, pv, [fv], [type])

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Principal Payment 23 ArgumentDescription rateInterest rate per compounding period perPeriod for which principal payment should be calculated. nperNumber of compounding periods pvPresent value fv Future value, residual left over after the loan is completed. Could be a balloon payment. Can be omitted if = 0. typeDesignates when payments are made Type 0 – end of period. Default. Type 1 – beginning of period PPMT(rate, per, nper, pv, [fv], [type])

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The CUMIPMT Function (Introduction) CUMIPMT calculates the cumulative interest between two periods CUMPRINC calculates the cumulative principal between two periods The arguments to both functions are the same Functions require the analysis tool pack add-in ALL 6 ARGUMENTS ARE REQUIRED, SCROLL DOWN TO SEE TYPE!

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Cumulative Interest Payments 25 ArgumentDescription rateInterest rate per compounding period nperNumber of compounding periods pvInitial loan amount (Present value). Start_periodStarting period. Begins at 1 and increments by 1. End_periodEnding period. Begins at 1 and increments by 1 typeDesignates when payments are made Type 0 – end of period. Default. Type 1 – beginning of period TYPE IS A REQUIRED ARGUMENT – SCROLL DOWN TO SEE IT! CUMIPMT(rate, nper, pv, start_period, end_period, type)

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Cumulative Principal Payments 26 ArgumentDescription rateInterest rate per compounding period nperNumber of compounding periods pvInitial loan amount (Present value). Start_periodStarting period. Begins at 1 and increments by 1. End_periodEnding period. Begins at 1 and increments by 1 typeDesignates when payments are made Type 0 – end of period. Default. Type 1 – beginning of period TYPE IS A REQUIRED ARGUMENT – SCROLL DOWN TO SEE IT! CUMPPMT(rate, nper, pv, start_period, end_period, type)

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