Lecture Introduction to Accounting: An integrated approach (6/e) - Chapter 11 Time value of money. The goals of this chapter are: Explain the risk/return relationship, use the time value of money concepts to solve present and future value problems. | Chapter 11 Time Value of Money Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin 11- What is the Difference between Return Of and Return On an Investment? Return OF Return of the initial amount invested Return ON Additional amount returned in excess (or less than) the amount invested 11- What is Risk? Risk The chance of an unfavorable outcome Inflation risk Risk of changing price levels Business risk Risk of a particular company going out of business Liquidity risk Risk that an investment cannot be converted into cash when needed 11- How are Risk and Return Related? Expected rate of return Estimated rate of return on an investment Risk premium Expected rate of return adjusted for inflation, business, and liquidity risk Note: The greater the risk, the higher the expected rate of return. 11- What is the Difference between Simple and Compound Interest? Simple Interest is calculated on principal only Interest (1) = Principal * Rate * Time Interest (2) = Principal * Rate * Time Compound Interest is calculated on principal plus accumulated interest Interest (1) = Principal * Rate * Time Interest (2) = (Principal + Interest [1]) * Rate * Time 11- What are the Time Value of Money Components? FV = future value PV = present value c = compoundings/payments per year r = annual interest rate n = total number of compoundings/payments ANN = annuity 11- What is the Future Value of $1? Answers the question: What amount will $1 grow to at some point in the future? Example: If we invest $2,000 today, what will it be worth in 5 years, if we earn 8 percent interest compounded quarterly? PV = 2,000 r = 8 c = 4 n = 20 ANN = 0, therefore: Answer: FV = $2, 11- Formula: FV of $1 PV * ($1 + r/c)n = FV $2,000 * ($1 + )20 = FV $2,000 * = FV $2, = FV 11- What is the Present Value of $1? Answers the question: What is $1 at some point in the future worth today? Example: If we receive $2,000 in 5 . | Chapter 11 Time Value of Money Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin 11- What is the Difference between Return Of and Return On an Investment? Return OF Return of the initial amount invested Return ON Additional amount returned in excess (or less than) the amount invested 11- What is Risk? Risk The chance of an unfavorable outcome Inflation risk Risk of changing price levels Business risk Risk of a particular company going out of business Liquidity risk Risk that an investment cannot be converted into cash when needed 11- How are Risk and Return Related? Expected rate of return Estimated rate of return on an investment Risk premium Expected rate of return adjusted for inflation, business, and liquidity risk Note: The greater the risk, the higher the expected rate of return. 11- What is the Difference between Simple and Compound Interest? Simple Interest is calculated on principal only Interest (1) = Principal * Rate
