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Finance 500.101 Engineering is $$$

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Finance 500.101 A dollar today is worth more than a dollar tomorrow: Compound Interest P 0 = principal 0 time units into the future (i.e., today) P n = principal n time units into the future where r is the annual interest rate

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Finance 500.101 A Dutchman Peter Inuit bought Manhattan from the Canarsie Indians for $23 in 1626. Who got robbed...? Assuming funds were invested at 6% compounded monthly since 1626. The investment today would be worth $23*(1+.06/12) (12*(2010-1626)) = $220 *10 9

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Finance 500.101 A dollar today is worth more than a dollar tomorrow: Present Value: where r is the annual interest rate US treasury bills sold at “discount”, so that when the bill matures, you receive face value. If you buy a one-year $10,000 bill with an interest rate of 3%, how much should you expect to pay for it?

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Finance 500.101 A dollar today is worth more than a dollar tomorrow: Effective Interest: Invest $10,000 in company stock. Ten years later, you sell the stock for $20,000. What was your effective annual rate of return?

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Finance 500.101 Interest compounded once per year Interest compounded q times per year Interest compounded continuously Compound interest—different forms

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Finance 500.101 DJIA 1900-2010

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Finance 500.101 Lease vs. Buy? Example: Honda Pilot EX AWD price = $33,595 (Chicago, 2006 figures) Purchase with 20% down and a 36 month loan @6.75% down payment = $ 6,719 monthly payment= $ 825 spent after 36 mo= $36,419 residual value= $23,701 total cost= $12,718 Lease for 36 months down payment= $ 2,000 monthly payment= $ 359 spent after 36 mo= $14,565 residual value= $0 total cost= $14,565

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Finance 500.101 Annuities: Equal payments paid (or received) over n time periods Future value of an annuity: where P n = the value of the annuity after n payments of P Multiply both sides by (1+r) to obtain Subtract the first equation from the second to obtain

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Finance 500.101 Annuity example: Each year for 20 years you deposit $1000 into an annuity at an interest rate of 5%. What will be its value in 20 years?

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Finance 500.101 Annuity example: You win $1M in a lottery which pays you in 20 annual installments of $50K? What’s it worth $$ today, i.e., what is its present value? Assume 5% interest. but, So,

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Finance 500.101 Applications of Opportunity Cost The concept of opportunity cost has a wide range of applications including: Consumer choice Production possibilities Cost of capital Time management Career choice Analysis of comparative advantage The opportunity cost of a decision is based on what must be given up (the next best alternative) as a result of the decision. Any decision that involves a choice between two or more options has an opportunity cost. Opportunity Cost

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Finance 500.101 The length of time required to recover the cost of an investment. Shorter paybacks are better investments. Problems with this metric: 1. It ignores any benefits that occur after the payback period and, therefore, does not measure profitability. 2. It ignores the time value of money. Payback Period

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C H A P T E R 7 Time Value of Money Chapter 7.

C H A P T E R 7 Time Value of Money Chapter 7.

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