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Using Timelines to Visualize Cashflows
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Time Line Example
i=10%
Years 0 1 2 3 4
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Checkpoint 5.1
Creating a Timeline
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Checkpoint 5.1: Check yourself
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Timeline
i=interest rate; not given
Time Period 0 1 2 3 4
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Simple Interest and Compound Interest
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Example 5.1
Simple Interest
Interest earned = 5% of $500 = .05×500 = $25 per year
Total interest earned = $25×2 = $50
Balance in your savings account:
= Principal + accumulated interest
= $500 + $50 = $550
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Simple Interest
Where,
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Compound Interest
For the second period, its charged on the sum of principle amount
and interest charged during the first period.
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Compound Interest
Where,
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Present Value and Future Value
Time value of money calculations involve Present value (what a cash
flow would be worth to you today) and Future value (what a cash flow
will be worth in the future).
In example 5.1, Present value is $500 and Future value is $551.25 (if the
yearly compounding rate is 5%).
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Example:
Example 5.1: The future value of $500 in 2 years with annual
compounding interest rate of 5% can be computed directly
from the formula:
FV2=PV(1+i)2 = 500(1+0.05)2=500(1.05)2=551.25.
Continue example 5.1 where you deposit $500 in savings
account earning 5% annual interest. Show the amount of
interest earned for the first five years and the value of your
savings at the end of five years.
You can do the calculation year by year
or use the formula for future value: FVn= PV(1+i)n
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Year by year compounding
YEAR PV or Interest Earned FV or
Beginning (5%) Ending Value
Value
1 $500.00 $500*.05 = $25 $525
2 $525.00 $525*.05 = $551.25
$26.25
3 $551.25 $551.25*.05 $578.81
=$27.56
4 $578.81 $578.81*.05=$28 $607.75
.94
5 $607.75 $607.75*.05=$30 $638.14
.39
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Use the Future Value Equation
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Annuity
A strategy for saving a little bit of money in the present and having a
big payoff in the future is called an annuity.
Determine how much money will accumulate over time given that equal
payments are made.
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Future Value of Ordinary and Due
Annuity
ORDINARY ANNUITY
F pmt
1 nr 1
nt
r
n
ANNUITY DUE
F pmt
1 r nt
n 1
1 nr
r
n
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The Present and Future Values of
an Ordinary Annuity
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Sinking Funds
1
r nt
n 1
For an annuity due the formula is
r
1 1
pmt F n
r
n
r nt
n 1
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Perpetuity
Interest i
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