1. Capital Budgeting Decisions UAA – ACCT 202 Principles of Managerial Accounting Dr. Fred Barbee

2. Time Value of Money UAA – ACCT 202 Principles of Managerial Accounting Dr. Fred Barbee

3. Future Value Today...Future... Add interest at interest rate “i” for “n” periods.

4. Principal Interest Rate Time Simple Interest

5.  Suppose you invest $100 at an interest rate of 10%. At the end of one year you would have $110.

6. Future Value of $1

7. FV of Single Cash Flow

8. Present Value

9. The Concept of Present Value Today...Future... Deduct interest at interest rate “i” for “n” periods.

10. The Formulas

11. Present Value Formula

12. Using the PV Formula  What is the present value of $1,000 received five years from now if your required rate of return is 12%.

13. Using the PV Formula

14. Present Value Factors

16. Compounding Illustrated Future Value Future Value $567.43 for 5 years @ 12% compounded annually

17. Compounding Illustrated 567.43 x 1.12 ------------$635.52 1 $635.52 ------------$711.78 2 $711.78 ------------$797.19 3 $797.19 ------------$893.65 4 $893.65 ------------$1000.88 5 Add interest for “5” periods at 12%.

18. Reverse Compounding Illustrated Present Value Present Value $1,000 for 5 years @ 12% compounded annually

19. Reverse Compounding Illustrated $635.53------------1.12$567.44 1 $711.79------------1.12$635.53 2 $797.20------------1.12$711.79 3 $892.86------------1.12$797.20 4 $1,000.00------------1.12$892.86 5 Deduct interest for “5” periods at 12%.

20. Practice Exercise 1 Using Present Value Tables

21. Practice Exercise 1  What is the present value of $100 received at the end of five years if the required return is 10%? Exhibit 14C-3 Present Value of $1 $100 ? 1 2 3 4 5 Years

23. Practice Exercise 2 Using Present Value Tables

24. Practice Exercise 2  What is the present value of $100 per year for five years if the required return is 10%? Exhibit 14C-4 Present Value of an Annuity of $1 in Arrears $100 ? 1 2 3 4 5 Years $100 ?

26. Practice Exercise 3 Using Present Value Tables

27. Practice Exercise 3  Examine the table “Present Value of $1”  Explain why the numbers decrease as you move from left to right in a given row.

28. The numbers decrease from left to right in a given row because cash received in the future is worth less the higher your required rate of return. Remember the formula:

29. Practice Exercise 4  Examine the table “Present Value of $1”  Explain why the numbers decrease as you move from left to right in a given row.  Explain why the numbers decrease as you move from top to bottom in a given column.

30. The numbers decrease from top to bottom in a given column because cash received further in the future is less valuable today. Remember the formula:

31. Practice Exercise 5 Calculate Present Value

32.  Suppose you face the prospect of receiving $200 per year for the next 5 years plus an extra $500 payment at the end of 5 years.  Determine how much this prospect is worth today if the required rate of return is 10%. Practice Exercise 5

33. Cash FlowPV FactorAmount $2003.791$758.20 500.621310.50 Total$1,068.70 N=5, i=10

34. Practice Exercise 6 Calculate Present Value

35.  Juanita Martinez is ready to retire and has a choice of three pension plans.  Plan A provides for an immediate cash payment of $100,000  Plan B provides for the payment of $10,000 per year for 10 years and $100,000 at the end of year 10.  Plan C will pay $20,000 per year for 8 years. Practice Exercise 6 8% Required Rate of Return

36.  Plan A:  Plan B:  Plan C: Cash FlowPV FactorTotal $10,0006.710$67,100 100,000.46346,300 $113,400 Cash FlowPV FactorTotal $20,0005.747$114,940 Cash FlowPV FactorTotal $100,0001.000$100,000