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Ch04 Petty FinMagm 6e

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of money

PowerPoint to accompany:

Learning Objectives

grows over time when it is invested

money

value) and bringing money back to the present (present

value)

explain how it differs from the nominal or stated interest

rate

Copyright 2012 Pearson Australia (a division of Pearson Australia Group Pty Ltd) 9781442539174/Petty/Financial Management/6th edition

Learning Objectives

(contd)

and present value

loan amortisation

concept of equivalent interest rates

Copyright 2012 Pearson Australia (a division of Pearson Australia Group Pty Ltd) 9781442539174/Petty/Financial Management/6th edition

Learning Objectives

(contd)

changing interest rates

Copyright 2012 Pearson Australia (a division of Pearson Australia Group Pty Ltd) 9781442539174/Petty/Financial Management/6th edition

investment during the first period is added to the

principal, and during the second period interest is

earned on the original principal plus the interest earned

during the first period

increasing rate each period: exponential behaviour

the following equation:

i/jm

(4.1)

compounded each year, and j is the annual rate of

compound interest or the nominal annual rate

(contd)

by the following equation:

(4.2)

periods

Future value

Investing a sum of money (present value) at compound

interest results in a future value

Future Value (FV)

$1418.52

i = 6% per half year

$1000.00

The future value at the end of the nth period, FVn, can

be determined using the following equation:

FVn = PV(1 + i)n

(4.3)

financial calculator, or a spreadsheet

future value of $1 for n periods at i%

can be found by multiplying PV by the FVIF as follows:

FVn = PV(FVIFi,n)

10

(contd)

(4.4)

(contd)

tables, however:

11

the aid of a financial calculator (p.86)

12

the aid of a financial calculator (contd)

13

mode

and cents), press 2ndF, then TAB, followed by 2

press 2ndF, then C/CE

be more accurate than those obtained using tables

14

The table below shows some of the functions used with Microsoft

Excel when moving money through time:

Present value

15

money representing a future payment that is discounted

at an appropriate interest rate to reflect the time value

of money and other factors

future value to the present value

particular future sum of money to its present value

to its present value

present value (pp.88-89)

used:

PV = FVn / (1 + i)n

16

(4-5)

8% p.a. compounded quarterly, how much would we

have to invest today?

Substitute FV=$3000, i =2% per quarter and n = 8

quarters (two years) into Equation 4-5:

PV = $3,000 / (1.02)8 = $3,000 / 1.17166

= $2,560.47

present

value (pp.88-89) (contd)

To determine an unknown PV, the following equation can

also used:

PV = FVn(PVIFi,n) (4-6)

p.a. compounded quarterly, how much would we have to

invest today?

Substitute FV=$3000, i =2% per quarter and n = 8

quarters (two years) into Equation 4-6:

PV = FVn (PVIFi,n) =

$3,000 (PVIF2%,8)

=

17

$2559.00

number

of

periods,

n

(p.90)

used:

n = log(FV/PV) / log(1 + i)

(4-7)

the sum repaid was $358.84 at an interest rate of 12%

p.a. compounded monthly?

n = log(358.84 / 300) / log1.01

= log1.19613 / log1.01

= 18 months

18

interest

rate,

i

(p.90-1)

To determine an unknown i, the following equation is used:

i = (FV/PV)1/n - 1

(4-8)

made

was compounded quarterly. Has the investment earned at

least 12% p.a.?

i = ($12 668/$10 000)1/8 - 1

= (1.2688).125 1

= 3% per quarter = nominal rate of 12% p.a

19

comparable (p.91)

the following equation is used:

EAR = (1 + j/m)m 1

(4-9a)

compounded twice per year?

EAR = (1 + 12/2)2 1

= (1.06)2 1

= 12.36% (greater than the nominal

interest rate!)

20

Simple interest:

principal borrowed or invested

SI = P x r x t

21

Annuities

for a specified number of periods

22

from a superannuation pension fund or interest

payments on bonds

payments are made at the end of each period

annuity

calculated using the following equation:

[(1+ i) n -1]

FVn = PMT

i

(4.11)

23

annuity: Table 4.3 (p.95) (contd)

24

ordinary annuity (p.96) (contd)

25

and a half years if the interest rate is 8% per annum

compounded quarterly? As remarked in relation to Table

4.3, this means the annuity has the following features:

PMT = $100 per quarter, n = 6 quarters, and i = 2% per

quarter (.02 as a decimal)

Answer:

annuity (contd)

following equation is used:

i(FV )

PMT =

(1+ i) -1

n

following

equation is used:

n = log[{FV.i/PMT} + 1]

log(1 + i)

26

(4.13)

(4.14)

rate

27

annuity

be calculated using the following equation:

(4-15)

28

ordinary annuity (p.98) (contd)

29

and a half years if the interest rate is 8% per annum

compounded quarterly?

quarter, n = 6 quarters, and i = 2% per quarter (.02 as a

decimal)

Ordinary Annuity (p.98) (contd)

30

Answer:

(p.100)

31

(p.100)

specified number of periods (terms)

annuity (contd)

(4.17)

n = -log[1 - (PV.i/PMT)]

log(1 + i)

32

(4.18)

Annuity due

the beginning of each period

(4.20)

33

Or:

(4.21)

due: Figure 4.4 (p.105)

34

two types of annuity differ:

Perpetuity

following equation is used:

PV = PMT/i

35

(4.22)

irregular

36

the PV of each individual cash flow are added

flows, the FV of the sum of the PV of each

individual cash flow is calculated

Bond valuation

37

A bond:

amount of interest each year (coupons) and a

principal amount at maturity

changes in financial markets

acquisition

bond:

[1- (1 + i) -n ]

FVn

PV PMT

i

(1 + i) n

38

(4.23)

39

12%, the PV would be lower

10%, the price (PV) would be higher

1. Draw a timeline

Identify what is known and needs to be known

3. Identify the class of problem

5. Formulate the problem

40

material

41

occur in different time periods

so cash flows need to be valued in such a way that they

are comparable

time value of money to ensure profitable investments

are made

End of Chapter 4

42

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