Lecture Managerial finance - Chapter 2 provides knowledge of time value of money. After studying this chapter, you will know: Future value, present value, rates of return, amortization. | Lecture Managerial finance - Chapter 2: Time value of money Chapter 2 Time Value of Money 1 Time Value Topics Future value Present value Rates of return Amortization 2 Time lines show timing of cash flows. 0 1 2 3 I% CF0 CF1 CF2 CF3 Tick marks at ends of periods, so Time 0 is today; Time 1 is the end of Period 1; or the beginning of Period 2. 3 Time line for a $100 lump sum due at the end of Year 2. 0 1 2 Year I% 100 4 Time line for an ordinary annuity of $100 for 3 years 0 1 2 3 I% 100 100 100 5 Time line for uneven CFs 0 1 2 3 I% -50 100 75 50 6 FV of an initial $100 after 3 years (i = 10%) 0 1 2 3 10% 100 FV = ? Finding FVs (moving to the right on a time line) is called compounding. 7 After 3 years FV3 = FV2(1+I)=PV(1 + I)2(1+I) = PV(1+I)3 = $100()3 = $ In general, FVN = PV(1 + I)N. 8 One Way to Find FVs Use a financial calculator. 9 Here’s the setup to find FV INPUTS 3 10 -100 0 N I/YR PV PMT FV OUTPUT Clearing automatically sets everything to 0, but for safety enter PMT = 0. Set: P/YR = 1, END. 10 What’s the PV of $100 due in 3 years if i = 10%? Finding PVs is discounting, and it’s the reverse of compounding. 0 1 2 3 10% PV = ? 100 11 Financial Calculator Solution INPUTS 3 10 0 100 N I/YR PV PMT FV OUTPUT Either PV or FV must be negative. Here PV = . Put in $ today, take out $100 after 3 years. 12 Finding the Time to Double 0 1 2 ? 20% -1 2 FV = PV(1 + I)N Continued on next slide 13 Financial Calculator Solution INPUTS 20 -1 0 2 N I/YR PV PMT FV OUTPUT 14 Finding the Interest Rate 0 1 2 3 ?% -1 2 15 Financial Calculator INPUTS 3 -1 0 2 N I/YR PV PMT FV OUTPUT 16 Ordinary Annuity vs. Annuity Due Ordinary Annuity 0 1 2 3 I% PMT PMT PMT Annuity Due 0 1 2 3 I% PMT PMT PMT .
