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CHAPTER 7
Time Value of Money
Future value
Present value
Rates of return
Amortization
Copyright © 2002 by Harcourt, Inc. All rights reserved.
7-2
0 1 2 3
i%
0 1 2 Year
i%
100
0 1 2 3
i%
0 1 2 3
i%
-50 100 75 50
0 1 2 3
10%
100 FV = ?
After 1 year:
FV1 = PV + INT1 = PV + PV(i)
= PV(1 + i)
= $100(1.10)
= $110.00.
After 2 years:
FV2 = PV(1 + i)2
= $100(1.10)2
= $121.00.
Copyright © 2002 by Harcourt, Inc. All rights reserved.
7-8
After 3 years:
In general,
INPUTS 3 10 -100 0
N I/YR PV PMT FV
OUTPUT 133.10
0 1 2 3
10%
PV = ? 100
FVn
PV = (1 + i)n = FVn ( 1+i)
1 n
.
PV = $100 ( 1
1.10 ) = $100(PVIF
3
i,n)
= $100(0.7513) = $75.13.
INPUTS 3 10 0 100
N I/YR PV PMT FV
OUTPUT -75.13
Solve for n:
FVn = $1(1 + i)n;
n
$2 = $1(1.20)
INPUTS 20 -1 0 2
N I/YR PV PMT FV
OUTPUT 3.8
Graphical Illustration:
FV
2
3.8
1
0 Year
1 2 3 4
Copyright © 2002 by Harcourt, Inc. All rights reserved.
7 - 17
Ordinary Annuity
0 1 2 3
i%
0 1 2 3
10%
INPUTS 3 10 0 -100
N I/YR PV PMT FV
OUTPUT 331.00
0 1 2 3
10%
INPUTS 3 10 100 0
N I/YR PV PMT FV
OUTPUT -248.69
0 1 2 3
10%
INPUTS 3 10 100 0
N I/YR PV PMT FV
OUTPUT -273.55
0 1 2 3 4
10%
$100 (1 + i )3 = $125.97.
INPUTS 45 12 0 -1095
N I/YR PV PMT FV
OUTPUT 1,487,261.89
INPUTS 25 12 0 -1095
N I/YR PV PMT FV
OUTPUT 146,000.59
INPUTS 25 12 0 1487261.89
N I/YR PV PMT FV
OUTPUT -11,154.42
0 1 2 3
10%
100 133.10
Annually: FV3 = $100(1.10)3 = $133.10.
0 1 2 3
0 1 2 3 4 5 6
5%
100 134.01
Semiannually: FV6 = $100(1.05)6 = $134.01.
Copyright © 2002 by Harcourt, Inc. All rights reserved.
7 - 33
EFF = 1 + (
iNom m
m
–1 )
=(1 + 0.10 ) – 1.0
2
2
= (1.05)2 – 1.0
= 0.1025 = 10.25%.
Or use a financial calculator.
Copyright © 2002 by Harcourt, Inc. All rights reserved.
7 - 39
EARAnnual = 10%.
mn
FVn = PV 1 +
iNom
.
m
2x3
FV3S
= $100 1 +
0.10
2
= $100(1.05)6 = $134.01.
FV3Q = $100(1.025)12 = $134.49.
Copyright © 2002 by Harcourt, Inc. All rights reserved.
7 - 45
What’s the value at the end of Year 3
of the following CF stream if the
quoted interest rate is 10%,
compounded semiannually?
0 1 2 3 4 5 6 6-mos.
5% periods
0 1 2 3 4 5 6
5%
EAR = ( 0.10
1+ 2 ) – 1 = 10.25%.
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7 - 49
NOM% = 10.
P/YR = 2.
EFF% = 10.25.
0 1 2 3
5%
90.70
82.27
74.62
247.59
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7 - 52
Amortization
0 1 2 3
10%
INPUTS 3 10 -1000 0
N I/YR PV PMT FV
OUTPUT 402.11
302.11
Principal Payments
0 1 2 3
Level payments. Interest declines because
outstanding balance declines. Lender earns
10% on loan outstanding, which is falling.
Copyright © 2002 by Harcourt, Inc. All rights reserved.
7 - 58