2-TimeValueofMoney.pptx

1

Time Value of Money

2

Time Value of Money

Future value

Amount to which investment will grow after earning interest

Present value

Value today of future cash flow

Key principle

\$1 today > \$1 tomorrow

3

FV of an initial \$100 after3 years (I = 10%)

FV = ?

0

1

2

3

10%

Finding FVs (moving to the right

on a time line) is called

100

compounding

4

After 1 year

FV1= PV + INT1

= PV + PV (I)

= PV(1 + I)

= \$100(1.10)

= \$110.00

5

After 2 years

FV2= FV1(1+I)

= PV(1 + I)(1+I)

= PV(1+I)2

= \$100(1.10)2

= \$121.00

In general,

FVN= PV(1 + I)N

6

Future values with annual compounding

7

What’s the PV of \$100 due in 3 years if I/YR = 10%?

10%

Finding PVs is the reverse of compounding; it is called

100

0

1

2

3

PV = ?

discounting

8

1.10

Solve FVN = PV(1 + I )N for PV

PV =

FVN

(1+I)N

= FVN

1

1 + I

N

PV

=

\$100

1

= \$100(0.7513) = \$75.13

3

9

What is the PV of this uneven cash flow stream?

0

100

1

300

2

300

3

10%

-50

4

?

?

?

-?

?= PV

10

What is the PV of this uneven cash flow stream?

0

100

1

300

2

300

3

10%

-50

4

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