Lawrence Gitman

***Rashmi Chaudhary***

Which is more Valuable?
 1000

$ now  1000 $ after 2 years

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Money NOW is worth more than money LATER!

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Future Value Versus Present Value
Financial decisions are based on either future value or present value

• Future value- cash
you will receive at a future date

• Present value- cash
in hand today

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Time Line

Horizontal line on which time zero appears at the left most end and future periods are marked from left to right Used to depict investment cash flows

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Time Line

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• Future value- value at future date of a present amount deposited and earning specified interest rate. (Compounding) • Present value-The current value of a future amount. The amount that have to be invested today at a given interest rate over a specified period for a future amount. (Discounting)
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Types of Cash Flows

Single Amounts

Annuities (a stream of equal periodic cash flows)

Mixed Stream (a stream of unequal cash flows )

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Future value of Single Amount
The General equation for the future value at end of period n is FVn= PV X (1+i)n

Where,
FVn= Future value at the end of period n PV= Present Value i= annual rate of interest paid n= number of periods that money is left for deposits
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Example
 Jane places $800 in a saving account paying 6% interest compounded annually. She wants to know how much money will be in account at the end of 5 years.

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Now in this example PV = $800, i = 0.06, n = 5 So, FVn= PV X (1+i)n FV5= $800 X (1+0.06)5=$1070.40

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Future value Relationship
(Interest rates, time periods, and future value of one dollar)

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Present Value of a Single Amount

The process of finding present value is often referred as discounting cash flow Inverse of compounding

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Example
Pam wishes to find the present value of $1700 that will be received 8 years from now. Opportunity cost is 8% We know, FVn= PV X (1+i)n so, PV= FVn = $1700 = $918.42 (1+i)n (1+8)8

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Comparing Present Value and Future Value

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Types of Annuities
• Ordinary Annuity cash flows occur at the end of each period • Annuity Due- cash flows occur at the beginning of each period.

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Future Value of an Ordinary Annuity

FVAn=PMT X (FVIAi,n)

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 Frank wishes to determine how much money he will have at the end of 5 years if he chooses annuity A. i=7%

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Present Value of an ordinary annuity

PVAn= PMT X (PVIFAi,n)

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Braden wants to know what should it most pay to receive $700 at the end of each year

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Annuity Due

Future value of an annuity due
FVIAi,n(Annuity due)= FVIAi,n X (1+i)

Present value of an annuity due

PVIFAi,n(annuity due)= PVIFAi,n X (1+i)

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Future value of a Mixed Stream
 Shrell expects a stream of mixed cash flows over the next five years and expects to earn 8%. What will be earned after five years if cash flows are immediately invested.

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Present value of a mixed stream
 Frey has an opportunity of receving mixed stream cash flows over 5 years. If he must earn 9%, what is the most he should pay.

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Application of time Value

 

Determining deposits needed to accumlate a future amount Determination of equal periodic loan payments EMI’s Finding interest rates Finding an unknown number of periods
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Have a nice Day…………….

***Rashmi Chaudhary***

***Rashmi Chaudhary***

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