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Chapters 4 Slide 1

Case 1

Slide 2

Case 1

Cash Flow

646% per year r .814 Slide 6 What Rate is Enough? Assume the total cost of a college education will be $50.05)2 = $1.05 = $2.000 x (1 + r)18 (1 + r)18 = 10 (1 + r) = 10(1/18) = 0.000 when your child enters college in 18 years.905 Compound Value of $1905 $1905 x 1.05)1 = $1.905 If Leon’s offered two-year deferral and bank interest is 5% per annum Value in 2 years (T=2) = 2000(1+. What annual rate of interest must you earn on your investment to cover the cost of your child’s education? Solve for r : Ct+T = Ct x (1 + r)T 50.100 Net Present Value: $2000/1.205 Present Value = 2000/(1.05)2 = $2.000 to invest today.05 = $2.05 = $1.100 Generalized Net Present Value Formula PV t = Ct+T / (1 + r)T Present Value of amount paid/received in 1 year = 2000/(1+.000 Slide 4 Generalized Compound/Present Value Formulas Generalized Compound Value Ct+T = Ct x (1+r)T Value in 1 year (T=1) = 2000(1+.000 = 5.13646 = 13.Slide 3 Compound Value: $2000 x 1.05)1 = $2. You have $5.

71 S crap V alue 4 40 0.780 S lide 8 Ne t P re se nt V a lue / Discounte d Ca sh Flow Fa st Tra ck (Discount 10%) Initial Investm ent 0 (100) 1 New Revenues 1 60 0.08)27 = $187.99 A ctual (Paym ent)/Receipt+ A51 P resent Value Factor (10% ) Net P resent Value Slide S low Tra ck (Discount 12%) (100) 0.Slide 7 It is estimated that a firm has a pension liability that will require a payment of $1.12) 47.909 (1/1.500.5 M in 27 years.00 Initial Investm ent 0 (100) 1 New Revenues 1 0 0.1) (100) 54.826 2 (1/1.59 Scrap Value 3 40 0.1) 45.12) 42.05 Tim e Adjusted Cash Flow (NP V) 34.1) 30.636 4 (1/1.55 2 60 0.909 (1/1.59 3 60 0.751 3 (1/1.12) 25.1) 2 60 0.1) 27.00 .893 (1/1.12) 2 60 0.826 2 (1/1.1) 49.5 M = 27 = .96 A ctual (Paym ent)/Receipt P resent Value Factor (12% ) Net P resent Value (100) 0.42 Tim e Adjusted Cash Flow (NP V) 15.000/(1.683 4 (1/1. What amount must the firm invest today to meet this obligation if it will receives an annual return of 8% on its investment Ct+T T r Ct = $1.797 2 (1/1.08 = $1.1) 49.83 3 60 0.18 A ctual (Paym ent)/Receipt P resent Value Factor (10% ) Net P resent Value S low Tra ck (Discount 10%) Initial Investm ent 0 (100) 1 New Revenues 1 0 0.32 Tim e Adjusted Cash Flow (NP V) 21.08 S crap V alue 4 40 0.712 3 (1/1.751 3 (1/1.

... PVt = Ct+1 / r Simplification: 0 1 2 3 …forever.forever… PV0 = $100 / 0...Slide 9 Some tips for computing NPV: • • • • Only add (subtract) cash flows from the same time period Use the Time Line Specify a cash flow for each time period (even when it is $0) Use an appropriate discount rate The general formula for calculating NPV: NPV= . Perpetuity • A Perpetuity is a constant stream of cash flows without end.1 = $1000 . |---------|--------|---------|--------. + CT/(1+r)T Slide 10 Perpetuity • A stream of constant cash flows that lasts forever Growing Perpetuity • A stream of cash flows that grows at a constant rate forever Annuity • A stream of constant cash flows that lasts for a fixed number of periods Growing Annuity • A stream of cash flows that grows at a constant rate for a fixed number of periods Slide 11.C0 + C1/(1+r) + C2/(1+r)2 + .(r = 10%) $100 $100 $100 .

13 . Growing Annuity .10 .g) 0 1 2 3 ………forever |----------|---------|---------|------(r = 10%) $100 $102 $104.02) = $1250 Slide 13.Slide 12. Growing Perpetuity • • A growing perpetuity is a stream of cash flows that grows at a constant rate (g) forever.1 – 1/(.0. Simplification: PVt = Ct+1 / (r .13)] = $249 FV3 = 100 x [(1.04 …(g = 2%) PV0 = $100 / (0.1)/.1(1.1] = $331 Slide 14. Simplification: PV Annuity T = Ct+1 × FV Annuity T = Ct+1 x (1 + r)T. Annuity • • An annuity is a stream of constant cash flows that lasts for a fixed number of periods.1 r 0 1 2 3 years |---------|--------|---------| (r = 10%) $100 $100 $100 PV0 = 100 x [1/.

000.454.363.984 500.000 x (1/.500.103.000 x 2.600.Value 1.000 + 2.000 0.1 . has asked you to evaluate various contract offers made by the team.500.306 t b) Payment Pres.000 700.000 for each of the three years starting immediately c) Annual payments of $1.82644628 0.000.636 1.1)3))) = 1.000 700.• A Growing Annuity is a stream of cash flows that grows at a constant rate over a fixed number of periods.000 1.05)6))) = 3.322.000 x (1/.000.1(1.Value 1.468 522. the number one draft choice of the Edmonton Oilers.7462154 d) 500.052.000 500.963 Semi-Annual Periods 0 1 2 3 4 5 6 Discount Rate 5% 1 0.10)3] = $253 FVT = $253 x 1.000 1.(1.351 4.000 700.000 over the next three years.500.7513148 Total 4.08 x [1 .052.90702948 0.314 1.552.000 700.984 Boris should select Option b) Total 4.8638376 0.()T] FV Growth Annuity T = PVGA t x (1+r)T 0 1 2 3 |---------|--------|---------| $100 $102 $104.000 700. Assuming the annual interest rate remains at 10% over the next three years.500.(1/(.000.(1 / (1 + r )] 2 = 1. which contract should Boris sign? Year 0 1 2 3 Discount a) Rate 10% Payment Pres.686 575.1(1.104 3.(1/(.500.000 1. with no further payments b) Annual payments of $1.000 for each of the three years starting one year from now d) A signing bonus of $500.000 700.600.000 payable immediately for a three year contract.984 Slide 15 – Net Present Value .978.1T PV Annuity t = C t+1 x [ 1/r .(1/(.600.000 + [1.202.600.921 604. a) $4.306 = 4.600.1) )))] = 1.05(1.000 1/1.02/1.500.000 1.000 666. starting in six months.90909091 0.239.48685 = 3.000 4.04 PV0 = 100/0.13 = $337 Slide 15 (r = 10%) (g = 2%) Boris Karmalov.545 1.82270247 0.000 700.963 = 1.978.600.Value 1 4.000 1.000 1.000 immediately and a semi-annual payment of $700.669 4.500.1 .892 548. The team has offered him the following mutually exclusive deals (meaning he can choose only one). Simplification: PV Growth Annuity T = × [1 .95238095 0.500.78352617 0.306 Payment 1.103.603.05 .000 x (1/.667 634.000 c) Pres.

607 0 1 2 3 4 5 6 7 8 !………. Present Value in year 4 of Growing Annuity paid at the beginning of the year 5 to 8 $12.!……….160 $13.04/1.!……….654 $13.686 0 1 2 3 4 5 6 7 8 !……….! Step 3.(1.!………. The current tuition and residents costs are $10.!……….!………. What funds should be set aside for his education now if these funds will earn a 7% investment return.!……….!……….607/(1.!………. He will enter college in 5 years and will be taking a 4 year undergraduate degree.!……….!……….! . and wish to establish a fund for your son’s college education.!……….!……….04)5 = $12.!……….07-.!……….654 $13.167 Tuition $10.!……….267 $43.!……….04) x [ 1 .000 $12. Tuition cost in 5 years $10000 x (1.!……….07)4 = $33.607 Present Value of Annuity (Year 4) $43.167 $12.Question: You have just received a sizable inheritance.167/(.!……….160 $13.167 $12.!……….07)4]= $43.!……….607 $12.! Step 2.686 0 1 2 3 4 5 6 7 8 !……….267 Present Value of Annuity (Year 0) $33. Slide 16 Step 1.!……….000 per year which is expected to increase by 4% per year. Current Present Value of the Growth Annuity $43.

Slide 17 N Nominal Inte • The stated periods .

1 r Growing Annuity: Present Value: × [1 .Slide 18 Slide 19 Compound/Present Value/Annuity/Effective Interest Rate Formulas Present Value: Compound Value: Perpetuity: Growing Perpetuity: Annuity: PV t FV T = CT / (1 + r)T = Ct x (1 + r)T Perpetuity t = Ct+1 / r Growth Perpetuity t = Ct+1 / (r . a) T = number of compounding periods W b r = interest rate g = growth rate CT = value in period T N .()T] Future Value: FVGA T = PVGA t x (1+r)T Where: t = initial period T = number of periods Ct = value in initial period Conversion of Nominal to Effective Interest Rate: e = [(1+r/T) T] .g) Present Value: PV Annuity T = Ct+1 x Future Value: FV Annuity T = Ct+1 x (1 + r) T.1 e = effective annual rate r = nominal annual rate 1.

04 4 (1/6) 2 -1= 0 3 5 = 3 5 % or .00 3 5 = 1 0 .04 ) (1+ 0 ) .0 0residential ent % 20 0 m ag am ortg e ortized over 2 years.0 3 0 9 . For exam ple: 4 annual m ag (nom rate) % ortg e inal E ffective rate is: (1 .0 0/(1 0 3 5 .0 3 0 9 .2 8 9 ) .3 0 9 -1= 0 3 5 = 3 5 % . this ent is an annuity but is based on the effec em th tiv on ly interest rate 4 The effective m . ortg es inal com pounded sem i-annually 2 Therefore the effective rate is the stated rate .4 $ . 0 This am onthly annuity for 2 0m 4 onths (1 x 2 years) 2 0 The m onthly interest rate would be: (1+ /2 . divided by 2then squared.0 % +4 ) 44 4 4 3 S .C alculatingaResidential Mortg e R (C ag ate anada) 1 All residential m ag are quoted as anom rate . or >If com pounded 6tim will g the effective es ive sem i-annual rate What is the m onthly paym for a4 $ 0 .0 /2 -1= .3 0 9 240 (1/12) Monthly Paym =$ 0 .(1 0 3 5 (1 3 0 9 ent 2 0 0 /. ince m ag are paid m ortg es onthly based on aconstant paym of principal and interest.0 3 0 9 /.0 3 0 9 .0 0 = . onthly rate is the rate that: > If com pounded 1 tim will g the effective 2 es ive annual rate.

495 $ $ 82.619) 157. Mort.5 5 121.555) (4 ) O tio 2 E u l M n lyP y e t p n : q a o th a m n s C sh R eived per Month a ec R ym Fa tor epa ent c Am ount D in1 Yea ue 0 rs R everse Mortg g ae H m E u inT nY a o e q ity e e rs $ 666.0 0 2 (6 $ 2 9 /1 0 ) 8 .619 $ $ 28 8 6 .000 (80.486% 5.4 5 .000 400 600 1. Mort.000 80. Net Equity $ 80. Repay.000) 120.67 (5) (6) (7) 67 6 8 .228 Value Rev.0 9 7 (5 $ 0 0 /1 0 ) 8 . Repay.495 268.7 3 (1 7 5 ) 4 .783 (1) Effective Monthly 0.4 5 2 C pound Interest om (7 $ 8 .4 x(((1 0 8 ) 67 6 .0 4 6 12 0 )-1 0 8 ) Future Va )/.0 9 ) )-1 ) + 5 /2 (1 (.0 9 ) + 5 /2 (1/6) 2 C pound Interest om Annua E tive l ffec MonthlyE tive ffec C pound Interest om 1 0 -1 (3 $ 0 0 x1 3 ) 8 .783 (111.R v rs M rtg g P n e e e o a e la Hm Eu Tdy o e q ity o a R e s M r a e(m x4 % ev r e o tg g a 0 ) N tE u e q ity R es M r a e ev r e o tg g Am Fe d in e s A p a a p r is l L a eg l C s g lo in T t l (B s fo r p y e t) o a a is r e a m n H m V lu in1 Y a s o e a e 0 er Nominal Annual $ $ $ 200. Net Equity $ $ 10 268.90% Funds R eceived R everse Mortg g R ym a e epa ent H m E u yinT nY r o e q it e ea s Home Value Rev.0 0x1 3 ) 20 0 .0 (2 (1 (.4 $ 111.0 0 .0 10 (4 $ 2 9 x1 5 8 ) 8 .0 4 6 lue of MonthlyAnnuity .987% R e s M r g g R te (2 ev r e o t a e a ) O t n1 p io : Lm Sm u p u 5.000 (147.164 (1 $ 0 .

(1/(.(1/(.ca/eng/publications/CreditCardsYou/CreditCardComparisonTables-eng.172.02492) .146% Case 1 Pay Now [(1+(.15 1.(1/(.60 $ 55.484.317.075% 0.667.0175/12)) 1.29 x [(1/.02492 36 )))] 2.492% 1.(1/(.76% 0.000.gc.315.25%/12 12 12 12 ] -1 ] -1 ] -1 Effective Monthly Rate ] -1 Payment Admin Fee HST Total $ $ $ $ 2.00 84.000.26 67.15 145% 1/1.9826 0.00 260.00 $ 2.9826 $ 2.02492(1.95 $ $ $ 89.75% 1.00 2.010.80 x [(1/.00146(1.358.00 349.95 Case 4 Convert balance after 12 months to HSBC Credit Card $ $ $ 89.90% 7.006045) .24 $ 2.00146(1.134.00146(1.95 3.69% 7.95) and HST payable upon purchase BRICK nominal rate on payment plan = 29.28 $ 407.90%/12 12.9826 2.01075) .00 67.80 2000/[(1/.90% 12.01075(1.36% 13. Monthly Payment Due Immediately 1.9826 $ 1.00146 12 Website for Comparitive Credit Card Rates: http://www.006045(1.33 $ 349.000.95 $ 2.50% 2.920.358.00 349.00 349.006045 2.95 260.95 Repayment Costs Bank Unsecured Loan Balance Monthly Payment Annuity PV HSBC Credit Card Balance Monthly Payment Annuity PV BRICK Balance Monthly Payment Annuity PV $ $ $ 2.00146 36 36 )))] )))] $ $ $ 2.asp 0p .28 118% Case 5 Accept Brick repayment plan $ $ $ $ $ 2.260.95 2.2990/12)) [(1+(.fcac-acfc.95 $ 349.78 84.00 349.00 $ $ $ 89.25% Effective Annual Rate (monthly compound) BRICK HSBC Bank Unsecured BRICK HSBC Bank Unsecured Discount Rate GIC Nominal GIC Effective GIC Eff.00146) .000.270.95 Case 5 Accept Brick repayment plan 12 34.65 2.95 260.01075 36 )))] 2.000.90% HSBC Credit Card nominal interest rate = 12.0725/12)) 29.95 260.971.78 0.99 2000/[(1/.604% [(1+(.90%/12 7.20 349.00 61.260.00 $ 349.1290/12)) [(1+(.00146) .75% Loan Rates Nominal Annual Rates BRICK HSBC Bank Unsecured 29.00 $ 2.75/12 Case 2 Pay in full after 12 months Case 3 Convert balance after 12 months to Bank Loan $ $ $ 89.26 0.25% Bank rate on 36 month GIC = 1.965.60 100% 102% 110% Case 1 Pay Now PV 36 Month Annuity 12 Month Discount PV at Period 0 Payment at Period 0 TOTAL PAYMENT Diffference $ % $ $ Case 4 Convert balance after 12 months to HSBC Credit Card $ 2.971.24 $ 224.00146) .(1/(.00146 36 )))] $ $ $ 2.172.95 260.260.35 0.35 61.(1/(.BRICK "Don't Pay a Cent" Event: Cost Analysis Components of Analysis 1 2 3 4 5 6 7 $2000 purchase interest free for 12 months Balance paid over 36 months Administration fee ($89.99 x [(1/.00146 36 )))] Total Cost Analysis Case 2 Case 3 Pay in full after Convert balance 12 months after 12 months to Bank Loan $ 2.90% Bank nominal rate on 3 year unsecured loan = 7.29 2000/[(1/.29 $ 2.