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BMFP 3582 Chapter 7 Time Value of Money (Present & Annual Woth)RRatings:

4.67

(1)|Views: 674|Likes: 8Published by Haery Sihombing

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https://www.scribd.com/doc/4266471/BMFP-3582-Chapter-7-Time-Value-of-Money-Present-Annual-Woth-R

05/09/2014

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TIME VALUE OF MONEYTIME VALUE OF MONEY& & INTEREST FORMULASINTEREST FORMULAS

7

Time Value of MoneyTime Value of Money

•

Time Value of Money

•

Money can “make”money if Invested

•

Centers around an

interest rate

The change in the amount of money over agiven time period is called thetime value of money

Interest RateInterest Rate

INTERESTINTEREST--MANIFESTATION OF THE TIMEMANIFESTATION OF THE TIME VALUE OF MONEY. THE AMOUNT PAID TO VALUE OF MONEY. THE AMOUNT PAID TOUSE MONEY. IT REPRESENTS THE GROWTHUSE MONEY. IT REPRESENTS THE GROWTHOF CAPITAL PER UNIT PERIOD.OF CAPITAL PER UNIT PERIOD.

INVESTMENTINVESTMENT

INTEREST = VALUE NOWINTEREST = VALUE NOW--ORIGINAL AMOUNTORIGINAL AMOUNT

LOANLOAN

INTEREST = TOTAL OWED NOWINTEREST = TOTAL OWED NOW--ORIGINAL AMOUNTORIGINAL AMOUNT

RENTAL FEE PAID FOR THE USE OF SOMEONEELSES MONEY…EXPRESSED AS A %

Economic EquivalenceEconomic Equivalence

•

Economic Equivalence

•

Two sums of money at two different pointsin time can be made economicallyequivalent if:

•

We consider an interest rate and,

•

No. of Time periods between the twosums

Equality in terms of Economic Value

Equivalence IllustratedEquivalence Illustrated

T=0t = 1 Yr

RM20,000 isreceived hereRM21,800paid back here

RM20,000 now is economically equivalent toRM21,800 one year from now IF the interest rate isset to equal 9%/year

Simple and Compound InterestSimple and Compound Interest

•

Two “types”of interest calculations

•

Simple Interest

•

Compound Interest

•

Compound Interest is more commonworldwide and applies to most analysissituations

Simple Interest

•

Calculated on the principal amount only

•

In a multiperiodsituation with simple interest:

•

The accrued interest does not earn interest duringthe succeeding time period

•

Normally, the total sum borrowed (lent) is paidback at the end of the agreed time period PLUS theaccrued (owed but not paid) interest.

•

Simple Interest is:

(principal)(interest rate)(time)(principal)(interest rate)(time)RMI = (P)(i)(n)RMI = (P)(i)(n)

Simple and Compound InterestSimple and Compound InterestCompound InterestCompound Interest

•

To

COMPOUND

–stop and compute theassociated interest and add it to the unpaidbalance.

•

When interest is compounded, the interest that isaccrued at the end of a given time period is addedin to form a NEW principal balance.

•

That new balance then earns or is chargedinterest in the succeeding time period

•

Interest then “earns interest”

Compound InterestCompound Interest

::

ExampleExample

•

Assume:

•

P = RM1,000

•

i = 5% per year compounded annually (C.A.)

•

N = 3 years

II

22

=RM52.50=RM52.50II

11

=RM50.00=RM50.001 2 3

P=RM1,0P=RM1,00000

II

33

=RM55.13=RM55.13

Owe at t = 3 years:RM1,000 + 50.00+ 52.50 + 55.13= RM1157.63

Interest formulasInterest formulas

1.F/P and P/F Factors2.P/A and A/P Factors3.F/A and A/F Factors4.P/G and A/G Factors5.Effective Interest Rate

P=Present value, F=Future Value, A=Annual equivalent amount,P=Present value, F=Future Value, A=Annual equivalent amount,i=Interest Rate, n=No. of interest periods,i=Interest Rate, n=No. of interest periods,

1.Single1.Single--payment Compound Amountpayment Compound Amount

F/P FactorF/P FactorTo find F given PTo find F given P

P

0

F

n

n

………….

Compound forward in time

F

n

= P(F/P,i%,n) = P(1+i)

n

ExampleExample--F/P AnalysisF/P Analysis

Example: P= RM1,000;n=3;i=10%Example: P= RM1,000;n=3;i=10%

What is the future value, F?What is the future value, F?

0 1 2 3

P=RM1,00P=RM1,0000F = ??F = ??

i=10%/yeari=10%/year

F

3

= RM1,000[F/P,10%,3] = RM1,000[1.10]

3

= RM1,000[1.3310] = RM1,331.00

2.Single2.Single--Payment Present Worth AmountPayment Present Worth Amount

P/F FactorP/F FactorTo find P given FTo find P given F

PF

n

n

………….

P/F factor brings a singleP/F factor brings a singlefuture sum back to a specificfuture sum back to a specificpoint in time.point in time.

P = F(

P/F,i%,n

) = F(1+i)

-n

ExampleExample – –P/F AnalysisP/F Analysis

Assume F = RM100,000, 9 years from now. What is Assume F = RM100,000, 9 years from now. What isthe present worth of this amount now if i =15%?the present worth of this amount now if i =15%?

0 1 2 3 8 9

…………

F

9

=RM100,000

P= ??i = 15%/yr

P

0

= RM100,000(P/F, 15%,9) =RM100,000(1/(1.15)

9

)= RM100,000(0.2843) = RM28,430at time t = 0

3.Equal3.Equal--Payment Series Compound AmountPayment Series Compound Amount

F/A FactorF/A FactorTo find F given ATo find F given A

0

…………..N

RM A per periodRM A per periodRMF

Find RM F given theFind RM F given theRM A amountsRM A amounts

F = A (F = A (

F/A, i, n F/A, i, n

)= A)= A

ii

n

1)1(

ExampleExample

Formosa Plastics has major fabrication plants inFormosa Plastics has major fabrication plants inTexas and Hong Kong. It is desired to know theTexas and Hong Kong. It is desired to know thefuture worth of RM1,000,000 invested at the end of future worth of RM1,000,000 invested at the end of each year for 8 years, starting one year from now.each year for 8 years, starting one year from now.The interest rate is assumed to be 14% per year.The interest rate is assumed to be 14% per year.

•

A = RM1,000,000/yr; n = 8 yrs, i = 14%/yr

Solution:Cash flows are indicated in RM1000 units. The F value in8 years is

F =

l000

(F/A,14%,8)

=1000( 13.23218) = RM13,232.80= 13.232million 8 years from now.

4.Equal4.Equal--Payment Series Sinking FundPayment Series Sinking Fund

A/F Factor A/F Factor

RM A per periodRM A per period

0

…………..N

R MF

Find RM A given theFind RM A given theFuture amt.Future amt. – –RM FRM F

(1)1

n

ii F

A = F ( A = F (

A/F, i, n A/F, i, n

)=)=

ExampleExample

How much money must Carol deposit everyHow much money must Carol deposit everyyear startingyear starting

,,

l year from now at 5.5% perl year from now at 5.5% peryear in order to accumulate RM6000 sevenyear in order to accumulate RM6000 sevenyears from now?years from now?

SolutionSolution

The cash How diagram from Carol's perspective fits theThe cash How diagram from Carol's perspective fits the A/F factor. A/F factor.

A= RM6000 ( A= RM6000 ( A/F,5.5%,7 A/F,5.5%,7) = 6000() = 6000(0.120960.12096) =) =RM725.76RM725.76per yearper year

The A/F factor Value 0f 0.12096 was computed usingThe A/F factor Value 0f 0.12096 was computed usingthe A/F factor formulathe A/F factor formula

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