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◼Future value
◼Present value
Time lines show timing of cash flows.
0 1 2 3
i%
0 1 2 Year
i%
100
Time line for an ordinary annuity of
$100 for 3 years.
0 1 2 3
i%
0 1 2 3
i%
-50 100 75 50
What’s the FV of an initial $100 after 3
years if i = 10%?
0 1 2 3
10%
100 FV = ?
After 2 years:
FV2 = PV(1 + i)2
= $100(1.10)2
= $121.00.
After 3 years:
In general,
INPUTS 3 10 -100 0
N I/YR PV PMT FV
OUTPUT 133.10
0 1 2 3
10%
PV = ? 100
Solve FVn = PV(1 + i )n for PV:
FVn
PV = (1 + i)n = FVn ( 1+i)
1 n
.
PV = $100 ( 1
1.10 ) = $100(PVIF
3
i,n)
= $100(0.7513) = $75.13.
Financial Calculator Solution
INPUTS 3 10 0 100
N I/YR PV PMT FV
OUTPUT -75.13
Solve for n:
FVn = $1(1 + i)n;
$2 = $1(1.20)n
Graphical Illustration:
FV
2
1 3.8
0 Year
1 2 3 4
What’s the difference between an
ordinary annuity and an annuity due?
Ordinary Annuity
0 1 2 3
i%
0 1 2 3
10%
INPUTS 3 10 0 -100
N I/YR PV PMT FV
OUTPUT 331.00
0 1 2 3
10%
0 1 2 3
10%
INPUTS 3 10 100 0
N I/YR PV PMT FV
OUTPUT -273.55
0 1 2 3 4
10%
$100 (1 + i )3 = $125.97.
INPUTS 45 12 0 -1095
N I/YR PV PMT FV
OUTPUT 1,487,261.89
INPUTS 25 12 0 -1095
N I/YR PV PMT FV
OUTPUT 146,000.59
INPUTS 25 12 0 1487261.89
N I/YR PV PMT FV
OUTPUT -11,154.42
100 133.10
Annually: FV3 = $100(1.10)3 = $133.10.
0 1 2 3
0 1 2 3 4 5 6
5%
100 134.01
Semiannually: FV6 = $100(1.05)6 = $134.01.
We will deal with 3 different
rates:
(
EFF = 1 +
iNom m
m )
–1
2
= (1.05)2 – 1.0
= 0.1025 = 10.25%.
Or use a financial calculator.
EAR = EFF% of 10%
EARAnnual = 10%.
mn
FVn = PV 1 +
iNom
.
m
2x3
FV3S
= $100 1 +
0.10
2
= $100(1.05)6 = $134.01.
FV3Q = $100(1.025)12 = $134.49.
What’s the value at the end of Year 3
of the following CF stream if the
quoted interest rate is 10%,
compounded semiannually?
0 1 2 3 4 5 6 6-mos.
5% periods
0 1 2 3 4 5 6
5%
EAR = ( 0.10
1+ 2 ) – 1 = 10.25%.
Or, to find EAR with a calculator:
NOM% = 10.
P/YR = 2.
EFF% = 10.25.
b. The cash flow stream is an annual
annuity. Find kNom (annual) whose
EFF% = 10.25%. In calculator,
EFF% = 10.25
P/YR = 1
NOM% = 10.25
c.
0 1 2 3
5%
90.70
82.27
74.62
247.59
Amortization
0 1 2 3
10%
INPUTS 3 10 -1000 0
N I/YR PV PMT FV
OUTPUT 402.11
Step 2: Find the interest paid in
Year 1.
INTt = Beg balt (i)
INT1 = $1,000(0.10) = $100.
302.11
Principal Payments
0 1 2 3
Level payments. Interest declines because
outstanding balance declines. Lender earns
10% on loan outstanding, which is falling.
◼Amortization tables are widely used--
for home mortgages, auto loans,
business loans, retirement plans, etc.
They are very important!
◼Financial calculators (and
spreadsheets) are great for setting up
amortization tables.