Chapter 8
Learning Objectives
The time value of money and its
importance to business.
The future value and present value of a
single amount.
The future value and present value of
an annuity.
The present value of a series of uneven
cash flows.
2
k = 8%
800
700
600
k = 4%
500
400
300
200
0
k = 0%
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16
Year
PV = 100 = 90.90
(1.10)1
$100
PV = 100 = 46.65
(1.10)8
8
$100
k = 0%
80
70
60
k = 5%
50
40
30
20
0
k = 10%
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16
Year
Calculator Enter:
N =8
I/YR = 10
FV = 100
CPT PV = ?
- 46.65
I/YR
8 10
PV
PMT
FV
100
9
322.10
I/YR
PV
PMT
5 10 -200
FV
?
10
10
Annuities
An annuity is a series of equal cash
flows spaced evenly over time.
For example, you pay your landlord an
annuity since your rent is the same
amount, paid on the same day of the
month for the entire year.
Jan
Feb
$500
Mar
$500
Dec
$500
$500
$500
11
$0
$100
$100
$100
12
$100
$100(1.08)2
$100
$100(1.08)1
$100
$100(1.08)0
$100.00
$108.00
$116.64
$324.64
13
$0
$100
$100(1.08)2
$100
$100(1.08)1
$100
$100(1.08)0
$100.00
$108.00
$116.64
$324.64
n
3
(1+.08)
-1
= 100
.08
= 100(3.2464) = 324.64
14
$0
$100
Enter:
N =3
I/YR = 8
PMT = -100
CPT FV = ?
$100
$100
324.64
N
I/YR
PV
PMT
FV
-100 ?
15
$0
$100
$100
$100
16
$0
$100
$100/(1.08)1
$100
$100
$100 / (1.08)2
$100 / (1.08)3
$92.60
$85.73
$79.38
$257.71
17
$0
$100
$100/(1.08)1
$92.60
$85.73
$79.38
$257.71
$100
$100
$100 / (1.08)2
$100 / (1.08)3
PVA = PMTx(
1-
1
(1+k)n ) = 100(2.5771) =
k
257.71
18
$0
$100
Enter:
N =3
I/YR = 8
PMT = 100
CPT PV = ?
$100
$100
-257.71
N
I/YR
PV
PMT
100
FV
19
20
$100
$100
$100
21
$100
$100(1.08)2
$100
$100(1.08)1
$108.00
$116.64
$125.97
$350.61
22
$100
$100(1.08)2
n
(1+k)
- 1 )(1+k)
FVA = PMTx(
k
DUE
$100
$100(1.08)1
$108.00
$116.64
$125.97
$350.61
=100(3.2464)(1.08)= 350.61
23
$100
$100
$100
Set Calculator to
Begin Mode
Enter:
N =3
I/YR = 8
PMT = -100
CPT FV = ?
350.61
N
I/YR
PV
PMT
FV
-100 ?
24
$100
$100/(1.08)0
$100
$100/(1.08)1
$100
$100 / (1.08)2
$100.00
$92.60
$85.73
$278.33
25
$100
$100/(1.08)0
$100.00
$92.60
$85.73
$278.33
$100
$100/(1.08)1
PVA = PMTx(
DUE
$100
$100 / (1.08)2
1-
1
(1+k)n
)(1+k)
= 100(2.5771)(1.08)
= 278.33
26
Amortized Loans
A loan that is paid off in equal amounts
that include principal as well as interest.
Solving for loan payments.
Solving for interest and principal paid.
27
Amortized Loans
$5,000
$?
ENTER:
N =5
I/YR = 6
PV = 5,000
CPT PMT = ?
$?
$?
$?
$?
1,186.98
N
I/YR
PV
PMT
FV
6 5,000 ?
28
Amortized Loans
You borrow $20,000 from the bank to purchase
a used car. You agree to make payments at the
end of each month for the next 4 years. If the
annual interest rate on this loan is 9%, how
much is your monthly payment?
1
1(1.0075)48
$20,000 = PMT
.0075
1
1 - (1+k)n
PVA = PMTx(
) $20,000 = PMT(40.184782)
k
PMT = 497.70
29
Amortized Loans
You borrow $20,000 from the bank to purchase
a used car. You agree to make payments at the
end of each month for the next 4 years. If the
annual interest rate on this loan is 9%, how
much is your monthly payment?
ENTER:
N = 48
497.70
I/YR = 9
PV = 20,000
CPT PMT = ?
N
I/YR
PV
PMT
FV
Note:
N = 4 * 12 = 48
48
20,000 ?
30
Perpetuities
A perpetuity is a series of equal
payments at equal time intervals (an
annuity) that will be received into
infinity.
PVP = PMT
k
31
Perpetuities
A perpetuity is a series of equal payments at
equal time intervals (an annuity) that will be
received into infinity.
Example: A share of preferred stock pays a
constant dividend of $5 per year. What is the
present value if k =8%?
PVP = PMT
k
$7,000,000
$7,000,000
$1,851,852
$3,429,355
$4,762,993
$4,410,179
$21,454,380
$2,000,000
$4,000,000
$6,000,000
$6,000,000
33
Solving for k
Example: A $200 investment has grown to $230
over two years. What is the ANNUAL return on this
investment?
$200
$230
230 = 200(1+ k)2
FV = PV(1+ k)n
Solving for k
Example: A $200 investment has grown to $230
over two years. What is the ANNUAL return on this
investment?
Enter known values:
N = 2
PMT
= 0
PV = -200
FV = 230
Solve for:
I/YR
7.24
= ?
I/YR
PV
-200
PMT
FV
230
35
Frequency
$500(1.09)2 = $594.05 Annual
$500(1.045)4 = $596.26 Semi-annual
$500(1.0225)8 = $597.42 Quarterly
$500(1.0075)24 = $598.21 Monthly
$500(1.000246575)730 = $598.60 Daily
36
Continuous Compounding
Compounding frequency is infinitely
large.
Compounding period is infinitely small.
Example: $500 invested at 9% annual interest for
2 years with continuous compounding.
FV = PV x e
FV = $500 x e
.09 x 2
kn
= $598.61
37