MMI1060 FINANCE

Lecturer: Tanya Kirsch

Class 1

Introduction to the course

The Time Value of Money
(Ref: Berk Ch. 3.3, 3.4 and Ch. 4)

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What is Finance?

Finance seeks the answer to the following:

1. Capital budgeting:
– What long-term investments in projects / products / companies… should I
make?

2. Capital structure:
– How should I fund my investments? (Debt, Equity?)

3. How much working capital should I have?

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Course outline
• Class schedule
• Textbook
• Financial calculator
• Tutorials
• Assessment:
• Weekly online Quizzes
• Midterm
• Final

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TIME VALUE OF MONEY

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“Compound interest is the eighth wonder of the world. He who
understands it, earns it ... he who doesn't ... pays it.”

Albert Einstein

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Time Value of Money: Where are we headed?

You have a string of regular payments:

- What are they worth in today’s money?
- What are they worth in the future?
- What about if the payments happen at the beginning of a month? Or at
the end of a month?
- What happens if the interest rates change? And what about
compounding interest?
- What happens if payments are weekly instead of monthly?
- What happens if payments continue forever?
- What happens if the payments increase steadily? Or change?

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Time Value of Money: Where are we headed?

To be able to calculate the Present Value and Future value of a stream of

cash flows, at any point in time, and with any combination of the following
characteristics:
– Ordinary annuity and Annuity due
– Perpetuity
– Growing annuity and Growing perpetuity
– Effective interest rates for a Quoted rate, where interest is compounded other-than-
annually, and payment periods are not equal to the interest rate compounding period

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Sections 3.3 and 3.4

CHAPTER 3: THE VALUATION

PRINCIPLE: THE FOUNDATION
OF DECISION MAKING
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Problem #1: A very simple example – Future Value (FV)

You invest $1,000 today in a bank account that pays you interest of 8% per
year
• What is the $1,000 worth in 1 years’ time?
• What is the $1,000 worth in 5 years’ time?

What about if you want to have $1,000 in your bank account in 5 years’ time –
how much would you need to put into the bank account today?

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Future Value and Present Value

• The General formula:

FV = PV x (1+r)t

• Where:
FV = Future Value
PV = Present Value
r = Interest rate / Discount rate / Cost of capital / Required return
t = number of periods

We rearrange this formula to solve for PV, r or t

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Handout: Final exam formula sheet

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Problem #2

You deposit $100 at the end of year one year, $200 at the end of year two,
and $300 at the end of year three. Assuming a 4% interest rate throughout:
* Draw a timeline!
a) How much will you have in three years?
b) How much of this is interest?
c) How much will you have in five years if you don't add additional
amounts?
d) What is this investment worth in today’s money?

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Problem #3: Lumpsum
Your sister is currently 8 years old. Your parents anticipate she will be going to
university in 10 years. They would like to have $100,000 saved up for her
education by the time she is 18. They have asked for your help in calculating how
much they need to save. Assume the savings account will pay 3% interest per
year.
1. How much money do they need to put into the account today to ensure that
they have $100,000 in 10 years?
2. Instead of putting a lumpsum into a savings account today, your parents
rather want to put money away at the end of each year.
How much will they need to save each year?

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CH. 4: THE TIME VALUE OF MONEY

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Level Cash Flows: Perpetuities & Annuities (4.1 - 4.3)

• Annuities (Page 104-110): Cash flows of equal amount every period for
a limited number of periods.
• Example: Loan payments for a car; Saving up for retirement…etc

1 1 
PV (annuity of C for N periods with interest rate r)  C   1  
r  (1  r ) N 

This is the formula for an ordinary or regular annuity – i.e. it gives you
the present value of an annuity where payments are at the end of each
period

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Problem #3: Annuity
Your sister is currently 8 years old. Your parents anticipate she will be going to
university in 10 years. They would like to have $100,000 saved up for her
education by the time she is 18. They have asked for your help in calculating how
much they need to save. Assume the savings account will pay 3% interest per
year.
1. How much money do they need to put into the account today to ensure that
they have $100,000 in 10 years?
2. Instead of putting a lumpsum into a savings account today, your parents
rather want to put money away at the end of each year.
How much will they need to save each year?

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Section 4.4

GROWING / SHRINKING ANNUITIES

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 Growing (or Shrinking) Annuities

• A growing annuity: Payments grow at a constant rate each period, for n periods

PMT1   1  g  
n

PV0  1    
k  g   1  k  

• You can use this formula for both growing and shrinking annuities

You need to use the

formula (not a
financial calculator)
for these examples

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Problem #3: Growing annuity

Your sister is currently 8 years old. Your parents anticipate she will be going to
university in 10 years. They would like to have $100,000 saved up for her education by
the time she is 18. They have asked for your help in calculating how much they need to
save. Assume the savings account will pay 3% interest per year.
1. How much money do they need to put into the account today to ensure that they
have $100,000 in 10 years?
2. Instead of putting a lumpsum into a savings account today, your parents rather
want to put money away at the end of each year. How much will they need to save
each year?
3. You parent decide they want to put a smaller amount in for the first year, and then
increase the amount they put into the account each year by 5%. How much will
they put into the account in the first year?

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 Key formulae (from the Formula sheet)

Future Value
FV = Investment  1  r 
t
PV =
1  r t
C C1
PV of a perpetuity = PV of a growing perpetuity =
r rg

C  1  1  (1  r ) t   (1  r ) t  1 
PV of annuity =  1   = C  FV of annuity = C   
r  (1  r ) t   r   r 

C1   1  g  
t

PV of growing annuity =  1    
r  g   1  r  

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Lecture 1 wrap

– Overview of the course

– Overview of the field of Corporate Finance
– Introduction to Time Value of Money
• The general formula [FV = PV(1+r)t]
• Annuities
• Saving for a long-term goal
• Growing / Shrinking annuities

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Key formulae

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Weekly tasks, and Forthcoming attractions

• Tutorial: No tutorial this week

• Recommended end-of-chapter problems
• Office hours: Thursdays, 2 – 3 pm via zoom
• Quiz 1:
– Opens Thursday, Sept 15 @ 11.59 pm
– Due Monday, Sept 19 at 11.59 pm
• Next week: TVM continued
– Perpetuities
– Amortizing loans
– Effective annual interest rates

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