Lecture Contemporary financial management (9th Edition) - Chapter 4: The time value of money. This chapter introduces the concepts and skills necessary to understand the time value of money and its applications. | 4 The Time Value Of Money Introduction This chapter introduces the concepts and skills necessary to understand the time value of money and its applications. t denotes time PV0 = principal amount at time 0 FVn = future value n time periods from time 0 PMT denotes cash payment (annuities only) PV denotes the present value dollar amount T denotes the tax rate I denotes simple interest i denotes the interest rate per period n denotes the number of periods Notation Simple Interest Simple Interest Interest paid on the principal sum only I = PV0 i n FVn = PV0 + I = PV0 + PV0 i n Compound Interest Compound Interest Interest paid on the principal and on prior interest that has not been paid or withdrawn FV1 = PV0(1+i)1 FV2 = FV1(1+i)1 = PV0(1+i)2 FV3 = FV2(1+i)1 = PV0(1+i)2(1+i)1 = PV0(1+i)3 Future Value of a Cash Flow At the end of year n for a sum compounded at interest rate i is FVn = PV0(1 + i)n Formula See Figure . In Table I in the text, (FVIFi,n) shows the future value of $1 invested for n years at interest rate i: FVIFi,n = (1 + i)n Table I When using the table, FVn = PV0(FVIFi,n) See Figure . Future Value of a Cash FVn = PV0(1 + i)n Tables Have Three Variables Interest factors (IF) Time periods (n) Interest rates per period (i) If you know any two, you can solve algebraically for the third variable. Present Value of a Cash Flow PV0 = FVn[1/(1+i)n] Formula PVIFi, n = [1/(1+i)n] Table II PV0 = FVn(PVIFi, n) Table II See Figure . Present Value of a Cash Flow PV0 = FVn[1/(1+i)n] Example Using Formula What is the PV of $100 one year from now with 12 percent (annual) interest compounded monthly? PV0 = $100 1/(1 + .12/12)(12 1) = $100 1/() = $100 (.88744923) = $ Example Using Table II PV0 = FVn(PVIFi, n) = $100(.887) From Table II = $ Annuity A series of equal dollar CFs for a specified number of periods Ordinary annuity is where the CFs occur at the end of each period. Annuity due is where the CFs occur at the beginning of . | 4 The Time Value Of Money Introduction This chapter introduces the concepts and skills necessary to understand the time value of money and its applications. t denotes time PV0 = principal amount at time 0 FVn = future value n time periods from time 0 PMT denotes cash payment (annuities only) PV denotes the present value dollar amount T denotes the tax rate I denotes simple interest i denotes the interest rate per period n denotes the number of periods Notation Simple Interest Simple Interest Interest paid on the principal sum only I = PV0 i n FVn = PV0 + I = PV0 + PV0 i n Compound Interest Compound Interest Interest paid on the principal and on prior interest that has not been paid or withdrawn FV1 = PV0(1+i)1 FV2 = FV1(1+i)1 = PV0(1+i)2 FV3 = FV2(1+i)1 = PV0(1+i)2(1+i)1 = PV0(1+i)3 Future Value of a Cash Flow At the end of year n for a sum compounded at interest rate i is FVn = PV0(1 + i)n Formula See Figure . In Table I in the text, (FVIFi,n) shows the future value of $1