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o Annuity Due
- An annuity with payments
that occur at the beginning
• Present Value (PV) of each period
- Beginning amount that can be
invested • Uneven cash flows
- Current value of some future - Multiple payments of different
amount amounts over a period of time
Where:
Rate (B2)
• Equations Number of periods (B1)
Present value (B3)
Payment (B4) (not used)
Type (B5) (not used)
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4-2b FV of an Ordinary Annuity – FVAn • Financial Calculator
o Ordinary Annuity
- “deferred”
- Payment made at the end of the
period
• Equation Solution
• Equation Solution
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4-3 Present Value (PV)
- The value today – that is, the current • Cash Flow Timeline
value of a future cash flow or series of
What is the PV of $400 due in 3 years if r = 5%?
cash flows
- To compute the PV of a future amount,
we “bring back” the future amount by
taking interest out for each future period
that the money has the opportunity to
earn interest
o Discounting
- “de-interest” the future
amount
• Equation Solution
- The process of determining
the PV of a cash flow or
series of cash flows to be
received (paid) in the
future
- Reverse of compounding
• Financial Calculator
• Equation Solution
4-3b PV of an Ordinary Annuity – PVAn
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• Financial Calculator 4-3f Comparison of FV with PV – Understanding
the Numbers
• Financial Calculator
• Financial Calculator
1. Input in “CF” register:
o CF0 = 0
o CF1 = 400
o CF2 = 300
o CF3 = 250
2. Enter I = 5, then press NPV button to 4-5 Annual Percentage Rate (APR) and
get NPV = -869.02. Effective Annual Rate (EAR)
o Annual Compounding
- The process of determining the
future (or present) value of a cash
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flow or series of cash flows when - Effective return earned on an investment
interest is paid once per year is higher than the stated rate (rSIMPLE)
o Semiannual Compounding
- The process of determining the
future (or present) value of a cash • Simple (Quoted) Rate (rSIMPLE)
flow or series of cash flows when - “periodic rate”
interest is paid twice per year - used to compute the interest paid
per period
4-5a Semiannual and Other Compounding
- Written/stated into contracts, quoted
Periods
by banks and brokers. Not used in
The FV of a lump sum be larger if we calculations or shown on time lines
compound more often, holding the stated r - Periods per year (m) must also be
constant? Why? given
𝑟
- Periodic rate = rPER = 𝑆𝐼𝑀𝑃𝐿𝐸
If compounding is more frequent than once a 𝑚
𝑛𝑃𝐸𝑅 = 𝑛𝑌𝑅𝑆 𝑥 𝑚
• Effective Annual Rate (rEAR)
nPER = total number of interest payment during - the annual rate of interest actually
nYRS years being earned
- Used to compare returns on
nYRS = number of periods
investments with different payments
m = number of interest payments per year per year
- The annual rate that causes PV to
❖ rPER = rSIMPLE and nPER = nYRS when interest grow to the same FV as under multi-
is compounded annually period compounding
❖ rPER < rSIMPLE and nPER > nYRS when interest - The rate that would produce the
is compounded more than once per same future value when annual
year interest compounding exists
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𝑟𝑆𝐼𝑀𝑃𝐿𝐸 𝑚 • Financial Calculator
𝑟𝐸𝐴𝑅 = (1 + ) −1
𝑚
0.10 2
= (1 + ) −1
2
= 10.25%
Where:
Pmt = payment
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Future Value Uneven Cash Flow Stream
Lump-Sum Amount 1 1 0
𝑃𝑉𝐶𝐹𝑛 = 𝐶𝐹1 ( ) + ⋯ + 𝐶𝐹𝑛 ( )
(1 + 𝑟)1 (1 + 𝑟)𝑛
𝐹𝑉𝐿𝑆 = 𝑃𝑉(1 + 𝑟)𝑛
Rate
Ordinary Annuity 𝑛 𝐹𝑉
𝑟= √ −1
𝑟 𝑛𝑚 𝑃𝑉
(1 + ) −1
𝐹𝑉𝑂𝐴 = 𝑃𝑀𝑇 [ 𝑚 ]
𝑟 Time
𝑚
𝐹𝑉
log [ ]
𝑛= 𝑃𝑉
Annuity Due log(1 + 𝑟)
𝑟 𝑛𝑚
(1 + ) −1 𝑟
𝐹𝑉𝐴𝐴𝐷 = 𝑃𝑀𝑇 {[ 𝑚 ] 𝑥 (1 + )}
𝑟 𝑚 Annual Interest Rate to Periodic Rate
𝑚 Conversion
𝑟𝑆𝐼𝑀𝑃𝐿𝐸
𝑟𝑃𝐸𝑅 =
𝑚
Uneven Cash Flow Stream
𝑛𝑃𝐸𝑅 = 𝑛𝑌𝑅𝑆 𝑥 𝑚
𝐹𝑉𝐶𝐹𝑛 = 𝐶𝐹1 (1 + 𝑟)𝑛−1 + ⋯ + 𝐶𝐹𝑛 (1 + 𝑟)0
Amortization
Ordinary Annuity
Payment
𝑟 −𝑛𝑚
1 − (1 + )
𝑃𝑉𝑂𝐴 = 𝑃𝑀𝑇 [ 𝑚 ] 𝑟
𝑟 𝑅 = 𝐴[ ]
𝑚 1 − (1 + 𝑟)−𝑛
Interest
Annuity Due 𝐼 = 𝑃𝑖
𝑟 −𝑛𝑚 Principal
1 − (1 + ) 𝑟
𝑃𝑉𝐴𝐷 = 𝑃𝑀𝑇 [ 𝑚 ] 𝑥 (1 + )
𝑟 𝑚 𝑃 = 𝑃𝑚𝑡 − 𝐼
𝑚
Perpetuities
𝑃𝑀𝑇
𝑃𝑉𝑃 =
𝑟
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